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Sector update: Oil & Gas - CGDs - The right time, the right place

The recent Petroleum and Natural Gas Regulatory Board (PNGRB; Downstream Oil & Gas regulator) notification on revised bid criteria for CGD licenses is a precursor to better times ahead for the Indian Gas sector - City Gas Distribution (CGD). Continuing benign gas price environment coupled with Indian government’s thrust to boost gas usage (from 6.5% of India’s primary energy mix currently to 15% over the next decade) through revised policy measures and aggressive infrastructure development would provide earnings traction to the 3 CGDs within our coverage - Indraprastha Gas (IGL), Mahanagar Gas (MGL) and Gujarat Gas (GGL). We estimate moderate 12%/5.7%/10% volume CAGR and 15%/4%/31% CAGR in earnings (even without factoring in new bid wins for the incumbents) over FY18-20E for IGL/MGL/GGL. The 3 stocks are well placed to leverage the material market opportunity in the Indian CGD space, especially given their attractive valuations post recent underperformance (1%/11%/3% for IGL/MGL/GGL over last 3 months). We reiterate our Outperformer rating on IGL/MGL/GGL with target price of Rs360/Rs1,150/Rs1,060, respectively.

Regulatory measures and CGD bid to open new growth vistas: We believe the Ninth round of bidding will be launched over next few days, and with 86 Geographical areas (GAs) comprising >174 districts on offer, we see new inorganic growth avenues for the 3 CGDs. We expect enhanced pollution control measures, mandatory conversion of state transport to CNG and aggressive transmission/LNG infrastructure development to aid higher gas consumption growth in India over next 5 years. Strengthening crude and product prices, which increase competitiveness for gas, would provide additional traction.

Supply to pick up, competiveness of gas to improve: We see material rise in domestic and LNG supply over FY19-23E to complement the rising demand for gas. While domestic gas output is slated to rise by ~40 mmscmd by FY23E, LNG import capacity will also rise by incremental >30mt (current base of 30mt nameplate capacity) by FY21E, providing enough cushion for the higher demand. 

Valuations & View – attractive levels: We estimate impressive 9-10% CAGR in Indian gas demand over next 5 years, with emerging growth in domestic and LNG sources sufficient to meet this demand. The CGD sector will be a major constituent of this growth and we expect the resultant volume growth to flow through to IGL/MGL/GGL through robust earnings over FY18-20E. Recent underperformance in the 3 stocks offers compelling opportunity to tap into the renaissance in the Indian gas space. At current valuations of 23x/16.4x/19.6x FY20E EPS, IGL/MGL/GGL offer 21-28% upside on our target price of Rs360/Rs1,150/Rs1,060 per share, offering an attractive entry point. We reiterate Outperformer rating on the 3 stocks. Higher-than-expected LNG prices, execution delays on gas infrastructure projects and a change in gas allocation policy are key downside risks to our estimates.