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Strong volumes, resilient margins

Mahanagar Gas (MGL) reported its Q1FY23 EBITDA at Rs2.86bn (down 6% YoY, up 32.5% QoQ) vs our estimate of Rs3bn. Adjusted PAT dipped 9% YoY (up 40.5% QoQ) to Rs1.85bn (I-Sec: Rs2bn). The marginal miss was driven by: i) weaker than estimated margins even as volumes surprised positively for the quarter. Management has attributed the dip to continued pressure of higher spot LNG costs and higher opex. We however note that both gross margin/scm and EBITDA/scm of Rs14.2/scm and Rs9.1/scm did grow 8.6% QoQ and 20.5% QoQ, respectively. This implies the impact of: 1) aggressive price increases taken over the past few months, and 2) tie-up(s) of term LNG volumes and premium domestic gas. This should help sustain margins at Rs14/scm (gross) and Rs9.5/scm (EBITDA) for FY23E-FY24E, despite the spectre of rising LNG and pooled gas costs. With ahead-of-estimated volume growth and abysmal valuations, coupled with robust return ratios, we see the risk-reward ratio strongly tilted in favour of reward. Upgrade to BUY, with a target price of Rs980/sh.

* Gas costs to remain elevated, but pricing actions have been positive: Domestic gas costs have risen by >US$3.5/mmbtu from Apr’22 with spot LNG blending at ~15% of priority sector allocations as of now. However, with the government providing pooled gas via GAIL at more palatable prices (blended prices at US$10.5/mmbtu as of now), tie-up of some term LNG and some premium domestic gas from RIL (aggregate volumes of 0.4-0.5mmscmd), should alleviate the sourcing cost pressures over FY23E-FY24E. Also, MGL has passed on all of the domestic gas cost hikes promptly over FY23TD, which creates comfort on margins.

* Volume growth prospects improving: Volume growth picked up sharply in H2FY22 post the covid crisis and we do believe annual volume growth will average a stronger 15%/6% over FY23E/FY24E vs 5.2% over FY21/FY22. Management stated that potential demand from MMR/Raigad will support 5-6% growth over the next 5-6 years. However, we note MGL had disappointing results in recent bids, winning no new areas. We therefore believe growth beyond FY25E will get tougher, hampering prospects over the longer term.

* Upgrade to BUY: With the stock price weakness seen in past six months (down 7%) and favourable multiples (at CMP, stock trades at 8.8x FY24E EPS and 3.7x EV/EBITDA), we turn bullish on MGL for next 12-18 months. We estimate an EPS CAGR of 22% over FY22-FY24E, supported by volume CAGR of ~10% p.a., gross margins of Rs14.8/scm and EBITDA/scm of Rs9.7/scm. Longer-term growth beyond FY25E-FY26E does seem challenging, but current valuation gaps and growth prospects are worth looking at, in our view. Our DCF valuation, factoring-in more conservative assumptions of 3% volume growth and EBITDA/scm of ~Rs9.5/scm, delivers a target price of Rs980/sh, 24% upside from CMP. Upgrade to BUY

* Key risks: i) Sharper than expected rise in gas costs, ii) inability to pass on gas cost increases, iii) sharper than expected fall in alternate fuel prices for CNG (Petrol/diesel)

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