Buy Gujarat Gas Ltd For Target Rs. 475 by Motilal Oswal Financial Services Ltd
Twin tailwinds emerging!
* Valuation de-rating largely over, in our opinion: Over the last six months, GUJGA’s share price has corrected 34%, with the stock now trading at 21x FY27E P/E. Weakness in the stock price was driven by 1) higher spot LNG prices leading to elevated raw material costs and 2) subdued industrial and commercial PNG volumes amid weak ceramic exports and weak competitiveness vs. other fuels like Propane. However, we now believe fundamentals are undergoing a transformative shift:
* Weaker crude and lower slope – the twin emerging tailwinds: A weak crude price outlook together with a lower pricing slope for natural gas (given the impending LNG glut) will drive down gas costs and increase competitiveness vs. propane. While Brent crude prices averaged ~USD75.8/bbl in 4QFY25, we forecast Brent to average USD65/bbl in FY26/FY27 (earlier: USD70/bbl). We estimate every USD10/bbl decline in Brent prices reduces the landed cost of natural gas by USD2.3/mmbtu. Further, according to our discussions with the listed and unlisted India CGD companies, new long-term gas contracts are already being signed for a 1.0-1.3% lower slope given the expected surge in LNG supply in 2HFY26 and beyond.
* Estimate ~INR2-3/scm margin expansion scope amid favorable fundamentals: About 37%/ 27% of GUJGA’s gas sourced is under long-term (majority Brent-linked)/spot contracts. We estimate that a USD10/bbl decline in crude prices and a simultaneous 1% decline in pricing slope can lead to an EBITDA margin improvement of INR2.8/scm for GUJGA. We think actual improvement might be lower as GUJGA might pass on some of the lower raw material cost benefits. Similarly, a USD1/mmbtu decline in spot LNG prices shall lead to an EBITDA margin improvement of INR1/scm for GUJGA. Also, we are building in a higher margin CNG segment to become 34% of GUJGA’s total volumes (from 29% in FY24), which should further support blended margins.
* Valuations at par with long-term average: GUJGA’s valuations have corrected 34% over the past six months, and the stock now trades at 23x 1-yr fwd P/E, slightly below its long-term average. We foresee limited downside from the current level amid the scope of margin expansion, robust CNG volume growth, and an expected uptick in Morbi volumes from 1QFY26. Additionally, our margin and volume estimates could see upside risks in case the fundamentals turn in favor of the company. We reiterate our BUY rating on GUJGA with a TP of INR475/sh
Twin tailwinds of lower slope and weaker oil prices unfolding
* We view the following as twin tailwinds for GUJGA in the coming years: 1) Brent to average USD65/bbl in FY26/FY27 (earlier forecast: USD70/bbl, 4QFY25 average: USD75.8/bbl), 2) lower pricing slope as LNG global supply expands.
* With the majority of GUJGA’s long-term (LT) contracts being Brent-linked (pricing: ~13-13.5% slope to Brent), falling crude prices should drive down gas costs and increase competitiveness compared to propane.
* The International Energy Agency (IEA) estimates global oil demand to grow by 1mb/d in CY25, primarily driven by upcoming petrochemical plants in China. However, non-OPEC+ countries are expected to increase oil supply by 1.5mb/d in CY25. IEA previously estimated that even with voluntary cuts staying in place, global oil supply shall exceed demand by at least ~1mb/d. However, OPEC+’s decision to gradually unwind 2.2mb/d voluntary cuts by Apr’25 shall widen the gap.
* Additionally, new import tariffs by the US on China shall adversely impact China’s economic growth, which might lead to a decline in the estimated oil demand growth. Hence, we believe that downside risk to oil prices prevails, which shall be beneficial for CGDs.
* Moreover, with ~27% of the gas sourced by GUJGA being spot LNG, the company shall benefit from the anticipated lower spot LNG prices in 2HFY26 and beyond.
Margin expansion of ~INR2-3/scm driven by favorable fundamentals
* According to our channel checks, the slope for mid-term Brent-linked contracts currently tracks the following trend: contracts slope for FY26/FY27/FY28 is at ~15.0%/13.5%/12.0% of the Brent crude price.
* We have estimated the benefits of a lower slope and reduced Brent prices w.r.t. the long-term contracts for GUJGA, having ~37% LT gas contracts, the majority of which are Brent-linked.
* Scenario 1: Brent price averaging USD75/bbl and pricing slope of 13.5%,
* Scenario 2: Brent price averaging USD65/bbl and pricing slope of 12.5%.
* We estimate that a USD10/bbl decline in crude prices and a simultaneous 1% decline in pricing slope can lead to an EBITDA margin improvement of INR2.8/scm for GUJGA. We think actual improvement might be lower as GUJGA might pass on some of the lower raw material cost benefits.
* We also estimate that for every USD1/mmbtu decline in spot LNG prices, the company shall have an ~INR1/scm improvement in margin.
* For deriving natural gas landed cost, we assume a 2.5% import duty, INR70/mmbtu regas charges, GAIL’s Zone 2 transportation tariff, and a 15% VAT. We also assume an exchange rate of INR86.2/USD.
Shell anticipates a softer spot LNG market in 2HCY25
* In its LNG outlook 2025 released recently, Shell highlighted that while global LNG demand and supply growth would align in 2025, the majority of supply expansion is anticipated in 2HCY25 and could potentially lead to a tighter spot LNG market in 1HCY25. Out of the expected capacity addition of 17-26mmtpa in 2025, Shell expects ~4-10mmtpa capacity to come up in 1HCY25. However, in 2HCY25, as new capacity becomes operational, LNG prices are expected to soften and should support LNG demand.
* In line with the IEA, Shell also expects the long-term demand outlook for LNG to remain robust, notwithstanding the noise around decarbonization and climate change. India and China are expected to be the primary drivers of global LNG demand growth, with Asia's regasification capacity projected to reach ~800mmtpa by 2030 (~620mmtpa in 2024).
* Shell has also cut its forecast for additional LNG supply entering the market between 2024 and 2028 by ~30mmtpa over the past two years, underscoring persistent delays in supply growth and project timelines. We believe shifting project timelines remain a risk going forward for our/Street’s base case scenario of softer spot LNG prices in 2HCY25.
Valuation and view
* The company’s long-term volume growth prospects remain robust, with the addition of new industrial units and expansion of existing units. It is aggressively investing in infrastructure to push industrial gas adoption in Thane rural, Ahmedabad rural, and the newly acquired areas in Rajasthan.
* The stock is trading at a P/E of 23x for FY26E and an EV/EBITDA of 12.6x for FY26E. We reiterate our BUY rating on the stock with a TP of INR475/sh, valuing it at 25x FY27E EPS.
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