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MOSL: OIL & GAS-CGDs – a difficult terrain ahead

Oil & Gas: CGDs – a difficult terrain ahead

 

• City Gas Distribution (CGD) companies are trading at 20-50% premium to global peers. Over the past one year, CGD companies have delivered returns of ~22-32% in absolute terms.
• Rich valuations, combined with the impact from the possible changes in the regulatory and operating environment, lead us to cut our target multiples.
• We downgrade our rating on MAHGL and GUJGA from Buy to Neutral, and maintain Buy on IGL. 

Trading at 20-50% premium to global peers

• Led by triggers in the form of (a) growth in existing areas, (b) intercity/highway travel on CNG, (c) implementation of BS-VI, (d) restriction on plying of diesel vehicles and (e) curbs on the usage of polluting fuels, IGL and GUJGA are likely to deliver 10-12% volume growth over the near-to-medium term. MAHGL’s volumes, though, are likely to grow at a slower rate of 7%.
• However, the recently concluded 9^th and 10^th rounds of CGD bidding – wherein IGL won four geographical areas (GAs), GUJGA won seven and MAHGL won none – cast doubts on the sustenance of these volume growth assumptions for the longer term.
• Considering the non-sustenance of volume growth in the longer run and the possible changes in the regulatory and operating landscape, the current premium of 20-50% over global peers appears stretched. 

Regulatory challenges ahead

• Our recent interaction with various industry experts suggests that almost arbitrary EBITDA/scm across companies is grabbing attention of the regulators. The regulator may be looking at enhancing competition in order to benefit consumers, and thus, push for higher adoption of gas.
• Marketing exclusivity of several existing GAs has already lapsed theoretically. However, a few of these have been challenged. Legally, the Petroleum and Natural Gas Regulatory Board (PNGRB) has to announce the lapse of marketing exclusivity, post which it would open up for other players to sell their gas using the existing pipeline network.
• Intensified competition would result in lower volume for incumbents and possibly lower EBITDA/scm for the industry, impacting RoEs and calling for lower valuation multiples.