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When the going gets tough…

Over the next 12 months, margins and/or volumes for listed gas companies will likely remain muted as the companies try to navigate the challenging macro environment of higher prices for both domestic and LNG, we believe. We, however, see the fall in stock prices across the gas universe as an excellent opportunity to invest in high-quality businesses with strong growth prospects. We believe despite higher LNG prices, city gas distribution (CGDs) companies such as Indraprastha Gas (IGL), Gujarat Gas (GGL) and Mahanagar gas (MGL) will gradually adjust to the new normal and margins will normalise over FY23-24E, supporting earnings, while the threat of electric vehicles (EVs), though material, is decadal and not an immediate one. For gas utilities GAIL, Gujarat State Petronet (GSPL) and Petronet LNG (PLNG), we believe that fortunes are a bit mixed, with GAIL being the standout performer, while PLNG and GSPL are more steady state performers over FY22-24E. Reinitiate coverage on gas companies with BUY rating on GAIL/IGL/GGL/GSPL, ADD on MGL and REDUCE on PLNG.

Broken demand-supply balance to not correct in a hurry: What started as a supply shortage due to covid/weather has now turned into a structural problem thanks to the Russia-Ukraine conflict. We do not really see the situation resolving anytime soon, and hence, assume spot LNG price of US$25-30/mmbtu, crude prices of $85/bbl and domestic gas prices of US$8.5/mmbtu for FY23E

CGDs to see turbulent times: In this backdrop, we expect the 3 CGDs companies – IGL, GGL and MGL – to see a tricky time to manage the balance between volumes and sourcing mix. IGL/MGL have increased the share of term LNG in their portfolio, while GGL has also tied up some more domestic gas supply from Vedanta (Cairn) and Reliance Industries (RIL). However, despite these attempts, average gas cost will likely rise to record levels for FY23E, necessitating sharply higher sales prices. Hence, we build in conservative EBITDA margin for FY23E of Rs7.0/4.8/8.8 per scm for IGL/GGL/MGL vs Rs7.5/4.3/9.2 per scm for FY22E.

Volume growth captive to margin realities: As mentioned before, due to incremental volumes subject to higher LNG availability, volume growth will need to be tempered by the need to keep input costs under control as CGDs can only increase sales prices up to a certain limit. We see volume CAGR of 11.9/7.7% for IGL/MG which still have relatively inelastic demand from domestic and CNG segments, but for GGL, we temper our expectations to 9% for FY22-24E

GAIL, a standout over the next 12 months: For gas utilities, the sharply higher price crimps volume growth, specifically for GSPL and PLNG. For GAIL, the global portfolio of sources and supply destinations implies that while transmission volumes remain steady, trading earnings will continue to grow robustly thanks to favourable differential between US HH prices and Asian Spot LNG, more than offsetting weaker petrochemical and LPG earnings

We see valuations/prospects at attractive levels: This is indeed a tricky time to recommend gas stories, given the evident challenges in both operational environment and pressure on financial metrics. However, the recent 9-22% dip seen in five of the six stocks covered in this note is enough of a trigger to have a closer look at selected names in the space. We believe gas demand in the country will grow at a strong pace over FY22-25E, with the quality and breadth of presence of GAIL/GSPL in transmission and of IGL/GGL in gas distribution coming to the fore over the medium term despite the near-term stress underpinning our BUY calls on these names. MGL also remains attractively valued, but there is limited traction seen on either volume or margin in the medium term. PLNG suffers from the persistent problem of capital allocation issues on top of a near- to medium-term utilisation challenge due to higher prices/rising domestic supply and competitive pressures. Re-initiating coverage on gas companies with GAIL/GGL/IGL/GSPL being preferred names (in that order), MGL at ADD and a REDUCE rating on PLNG.

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