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Higher LNG costs dent margins; valuations still stretched; Hold

* GGL’s Q2FY22 EBITDA/PAT of Rs4.21bn/Rs2.49bn (down 43%/48% yoy and 42%/48% qoq) missed estimates by 19%/25% due to lower margins as unit gas costs were higher than expected. Other Income of Rs192mn was also 35% lower than expected.

* Gas sales volumes rose 16% yoy/14% qoq to 11.4mmscmd, 4% above our expectation. Industrial PNG was up 11% yoy/12% qoq at 8.7mmscmd. CNG volumes jumped 53% yoy/26% qoq. Domestic PNG was flat yoy, while Commercial PNG rose on a low base.

* Net realization rose 4% qoq, while unit gas costs were up 25%. Hence, gross margin declined 42% to Rs6.1/scm, a 19% miss. Unit opex fell 4% yoy and 18% qoq. EBITDA/scm came in at Rs4.0 vs. our estimate of Rs5.2 (down ~50% each yoy and qoq).

* We cut our FY22E EPS by 16% on lower margins as well as volumes. However, we raise DCF estimates due to Amritsar-Bhatinda and Ahmedabad GAs, and higher CNG share ahead. Our DCF-based Dec’22 TP is Rs630 (vs. Rs520 Mar22 earlier). Retain Hold.

Highlights: Domestic PNG/commercial PNG volumes rose 8%/37% qoq. Employee costs fell 5% yoy/12% qoq. Other Expenditure rose 17% yoy/fell qoq 4% to Rs1.71bn. Depreciation was largely in line, while the tax rate was 25.5% in Q2. Interest costs fell 23% qoq to Rs123mn

Guidance: Current volumes stand at 12mmscmd and demand is steady with no impact from Morbi and other customers due to price hikes. In Q2, Morbi volumes were at 6.4mmscmd. GGL expects FY22 exit rate at 13mmscmd+ and maintains 10%+ overall with a 15% CNG volume CAGR guidance going ahead. It added 26 CNG outlets in Q2, while the annual plan is 150. GGL expects Q3FY22 margins to be similar to Q2. The recent price hike covers over USD20/mmbtu spot, which was for Oct’21 delivery, but Nov’21 would be USD30/mmbtu+. Hence, a price hike is required in Nov’21. GGL expects margins to recover in Q4 as spot cools off. Overall EBITDA guidance remains at Rs4.5-5.5/scm annually. Capex for H1 was Rs4.8bn, while FY22 guidance is Rs8-8.5bn. Net debt as of Q2-end was Rs2.4bn.

Near term challenging, spot cool off awaited: GGL may need to take another Rs10/scm hike in Nov’21 if the 12mmscmd run rate continues, though there may be some decline in volumes due to the Diwali season. Further price hikes may also eventually affect demand. We, hence, see a recovery in margins from Q4-Q1FY23, subject to a decline in spot LNG.

Valuation: We cut FY22E EBITDA/scm by 6% owing to ongoing pressure and FY22E/23E volumes by 8%/6%. Though, our medium-term margin and volume estimates in DCF are up on a higher CNG mix and new areas like Amritsar-Bhatinda and Ahmedabad Rural adding up, respectively. We roll over our DCF to Dec’23E. Maintain Hold with EW. Key risks: adverse oil-gas-LNG prices, currency, regulations, competition and operational-project issues.

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