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Higher costs to impact profits in near term…

About the stock: Gujarat Gas is one of India’s largest city gas distribution companies with highest sales volume among listed peers.

* Sales volume grew at 15% CAGR in FY17-21 driven by industrial PNG

* The company benefitted from NGT order for Morbi industrial area

Q2FY22 Results: Gujarat Gas reported results that were lower than estimates on the profitability front due to higher gas costs.

* Revenue was up 43.8% YoY to | 3614.5 crore (estimate: | 3554.1 crore) driven by growth in sales volume as well as realisation

* Gross margin was at | 6.1/scm, down | 4.2/scm YoY and | 4.4/scm due to a sharp surge in gas costs. Subsequently, EBITDA was | 421 crore, down 42.6% YoY and 41.8% YoY (estimate: | 446.4 crore)

* PAT was at | 249.1 crore, down 47.5% YoY, 47.7% QoQ (estimate: | 271.1 crore)

What should investors do? Gujarat Gas’ margins are likely to remain at lower levels in the near term given the current trend in global gas prices.

* WE maintain our HOLD rating on the stock

Target Price and Valuation: We value GGL at | 645 i.e. 28x P/E on FY23E EPS

Key triggers for future price performance:

* Strong volume growth in industrial PNG segment driven by Morbi industrial volume. Steady growth in CNG, domestic PNG to support volume growth

* Better pricing power and regulatory tailwinds over long term

* In the medium term, higher gas prices to impact margins. Further price hikes will be key monitorable

Alternate Stock Idea: Apart from GGL, in our oil & gas coverage we also like Gail.

* Gail is India’s leading gas transmission company, which is a beneficiary of increasing gas consumption. Stable volume growth along with higher profitability from gas trading, petchem and LPG segment due to higher oil prices will add value

* BUY with a target price of | 175

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