Company update: Gujarat Gas (Outperformer) - Resetting expectations, View unchanged

We present our revised estimates for Gujarat Gas (GGL), post the domestic price hike in October (Our note here )and our recent interaction with the company’s management. In our view, GGL’s growth prospects remain undiminished, notwithstanding its lack of success in the latest City Gas Distribution (CGD) bid round, with the company already seeing traction from 11-12 additional districts being developed over last 2 years, GGL is also close to finalising the buyout of GAIL’s 50% stake in Vadodara Gas, subject to regulatory clearances, while our sense is that the Amritsar/Bhatinda licenses might be transferred to GGL from group company GSPC Gas. Overall, the company is on track to double volumes by FY23E to ~12 mmscmd from 6.4 in FY18. We moderate our margin assumptions over FY19-21E by Rs0.2-0.3/scm, to factor in a stronger LNG price environment and steadily rising domestic gas costs. Even at revised assumption and lower target multiple, our target price of Rs875/sh implies 46% upside from the current level. Reiterate Outperformer.

No slowdown in volume growth: Current volume run rate of 6.6 mmscmd and a guidance of >7mmscmd exit rate for FY19E imply that our assumptions of 6.7/7.4 mmscmd for FY19E/FY20E remain on point, with additional delta from new areas (0.55 mmscmd by FY20E) to support growth. With 23 districts in its kitty (in 19 geographical areas), we expect ~14% CAGR in group volumes over FY18-23E.

Margin recovery in Q3; our estimates conservative: The recent price hike in Oct ensures a sharp recovery in GGL’s margins post an expected weak Q2. However, we have been conservative and have factored in modest margin improvement over FY19-21E. In our view, the company’s focus on enhancing volumes over margins in new areas could cause margins to soften during the period.

Valuations undemanding, Outperformer: Even at softer EBITDA/scm assumptions of Rs4.4/4.6 over FY19E/FY20E (versus ~Rs5 earlier), which drives ~10/11% downgrade in FY19-20E EPS, we see EPS growing >35% annually over FY19-20E. We introduce FY21E EPS estimate of Rs46.6/sh, which implies robust 23% CAGR over FY19-21E. At 12.9x FY21E EPS/5.9x EV/EBITDA, we believe stock is attractively priced, given the strong EPS growth and RoE/ROCE of 22%/23% in FY21E (+540/760bps versus FY18). Our DCF-based valuation delivers a revised target price of Rs875/sh, a 46% upside from the current level. We reiterate our Outperformer rating on the stock.