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Robust volumes; margin disappoints

Gujarat Gas (GGL) posted Q2FY22 EBITDA of INR4.2bn (-43% YoY, -42% QoQ), missing our and consensus forecasts as input spot LNG gas surged 5x YoY/ 2x QoQ. A similar trend played out at Mahanagar Gas.

Takeaways: i) Q2FY22 volumes rose 16% YoY (14% QoQ), with CNG surging by 53% YoY (+26% QoQ). ii) EBITDA margin/SCM dipped 50.4% YoY as 10% high-priced spot LNG was mixed to fulfil a sudden 53% YoY surge in CNG demand. Management expects full restoration of lowpriced APM gas from Nov-21. ii) Furthermore, GGL has shifted 1/5th of total sourcing to domestic difficult gas, which attracts 1/5th of spot LNG prices. iii) End-user tile industry’s strong margins and volume growth shall enable GGL to take further price hike from Nov-21.

Morbi-led strong volume with healthy pricing

Q2 volumes came in at 11.4mmscmd (+15.8% YoY, +14% QoQ), and are likely to remain flat at ~11.5mmscmd in Q3FY22. Industrial volume surged 10.6% YoY with strong CNG volumes (+53% YoY) despite retention of some travel restrictions. Morbibased players are targeting 60 new plants with INR500bn in capex by Dec-21. In addition, GGL sharply hiked industrial gas price by INR14/scm (42%) in Sep–Oct. GGL shall take another price hike shortly as end-user industry, tiles, has strong volumes as well as margins. GGL plans to add 150 CNG stations/year, 3x the earlier level, and ~0.15mn of domestic connections/year, thereby taking total to 2mn connections in three years.

Muted margins due to 5x YoY surge in spot LNG price

EBITDA margin remains muted at INR4/scm (-51% YoY) and gross margin at INR6.1/scm (-41% YoY) due to a 5x YoY surge in spot LNG prices. In order to buffer the impact of sharply rising input spot LNG prices, GGL increased the input gas mix from Cairn/ Vedanta gas, which is cheaply available at USD6.2/8.5/mmbtu compared with spot price of ~USD33/mmbtu, enabling unit opex dip of 3.5% YoY. The company enjoys absolute margin leverage as its margins are nearly one-third that of Adani Gas and MGL, while competing product propane is 20%+ more expensive.

Outlook and valuation: Strong structural move; retain ‘BUY’

We believe GGL will sustain strong double-digit volume growth, particularly driven by new geographies as well as strong growth in the high-margin industrial/CNG business with a significant surge in volumes fuelled by rising Morbi exports. Maintain ‘BUY/SO’ with a DCF-based TP of INR896 at 18x FY23E PER.

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