Gujarat Gas Ltd. share price target

Our recent interaction with the Gujarat Gas (GUJGA) management reinforces our core investment thesis.

Crude prices witnessed a sharp decline in March due to spread of Covid-19 across the globe and Opec deal failure. A likely increase in oil output by both Saudi Arabia and Russia from Q1FY21E and lower demand are expected to lead to a sizeable oversupply in the oil market. Subsequent low oil prices are expected to significantly affect ONGC's profitability....

Crude prices witnessed a sharp decline in March due to spread of Covid-19 across the globe and Opec deal failure. A likely increase in oil output by both Saudi Arabia and Russia from Q1FY21E and lower demand are expected to lead to a sizeable oversupply in the oil market. Subsequent low oil prices are expected to significantly affect ONGC's profitability....

25 February 2020 GUJGA has a long-term contract with Shell which will expire gradually by 2024. Volumes under the contract have already reduced from 2.5mmscmd to 2.2mmscmd and are expected to decline to 2mmscmd from 2020. Due to the supply glut globally, LNG prices have declined from USD6.0/mmBtu in 2019 to below USD3/mmBtu this year. Replacement by low-cost LNG would improve profitability. The company is also ramping up its capacity at Morbi to enable it to handle ~8mmscmd. It has already levied INR4b of fine on the Morbi cluster in 2019. We believe that further volume boost like Morbi could come up across the country. Gujarat is home to critically/severely polluted industrial clusters such as Rajkot, Ankleshwar, Batala, Bhavnagar, Tarapur and Vapi. Any development on this front could boost volumes significantly. GUJGA stated that customers with volumes of 2-2.5mmscmd had already shifted to dirtier fuels.

RMTL's order book as on February 1, 2020 was at | 1569 crore. Higher margin SS order book was at | 516 crore (| 536 crore as on October 1, 2019) and CS orders of | 1053 crore (| 1390 crore as on October 1, 2019). This is the third consecutive quarter wherein higher margin SS orders have stayed above the | 500 crore mark, auguring well for RMTL. In terms of domestic and exports mix, domestic orders were at | 1121 crore while export orders were at | 448 crore. Of the | 1121 crore domestic order book: | 403 crore is in the SS segment while balance | 718 crore is in the CS segment. Of the | 448 crore...

We believe that GGL will pass on partial benefit of falling RMC to industrial customers. This will ensure sustainability of volumes but will keep Gross Margins under pressure. The company will enjoy operating leverage led by increased volumes, which enable GGL to maintain per unit EBITDA (~Rs 4.3/scm over FY20-22) compared to Rs 4.96 in 1HFY20. We change our FY20/21/22E EPS estimates to factor in the 9M performance by -0.9/+0.4/1.2% to Rs 12.4/12.3/14.1 (vs the consensus of Rs 13.8/21.6/29.5). We downgrade GGL to Neutral despite an in-line EBITDA/PAT in 3QFY20, owing to 5.9% lower volumes than anticipated. Our TP is Rs 273, 20x Dec-21x EPS, versus the consensus TP of Rs 267.

5 February 2020 Reported EBITDA marginally exceeded our estimate (by 5%) owing to higher- than-expected EBITDA/scm of INR4.3. Volumes were in line with our estimate at 9.2mmscmd. The National Green Tribunal has mandated penalty against the Pollution Control Boards that do not comply with its Nov19 order of curbing pollution in critically and severely polluted industrial clusters across India. We have already noted that the NGT order did pan out strongly at Morbi, and any such order could further benefit GUJGA, industrial being its largest segment. Reduced interest cost was offset by lower other income. the company took DTL benefit in 2QFY20). For 9MFY20, EBITDA was up 65% YoY at INR12.1b, supported by the NGT ban at Morbi volumes from 1QFY20. PBT doubled to INR8.8b (v/s INR4.4b YoY), while PAT stood at INR9.

At our recent meeting, GUJGA's management assured robust outlook on volumes driven by (a) implementation of anti-pollution measures by the state government (new CNG state buses), and (b) relatively low LNG prices.

Oil & Gas City gas distribution (CGD) companies are expected to deliver robust volume growth in near term owing to favourable global macro scenario as well as the conducive regulatory policies in India. Their capex intensity is likely to remain high in the medium to near term. Benign LNG prices and focus on CNG market will enable GGL to sustain volumes and expand margins. For IGL, expansion of network in existing and new GAs will ensure volume growth of ~11-12% over FY21-23. OIL has guided for a flattish crude oil and gas production while ONGC expects ~6-7% YoY growth in the gas production over FY20-22E. ONGC also indicated that the proportion of high priced gas will jump by 10% to 14%. Chemicals Softer raw material prices and favourable market for Acetonitrile is enabling Alkyl Amines to maintain stronger margins. Recovery in the pharmaceutical and agrochemical sector (together comprise ~70% of sales mix) will result in volume growth of ~10-15% YoY in FY20. Slowdown in the auto industry will continue to impact the demand for rubber and rubber chemicals for the next few of quarters, at least. Wide applicability of Apcotex's products shielded the impact of slowdown to some degree but NOCIL will continue to witness sluggish demand. We hosted the Oil & Gas and Chemicals Investor Forum in Mumbai with 13 corporates/experts participating in the event.

We believe that GGL will pass on partial benefit of falling RMC to industrial customers. This will ensure not only sustainability of volumes but boost gas demand. This is particularly true for Morbi tile manufacturers (gas cost is ~20% of total tile RMC). Operating leverage led by increased volumes will allow GGL to maintain healthy per unit EBITDA (>Rs 4.3/scm over FY20-22). We remain positive on GGL as it will generate OCF yield of almost 9.7% and RoE of >22% over FY21/22E. Valuations are contextually low at 16.8/14.7x FY21/22E EPS. The sustainability of volume enables us to keep our faith intact on GGL. We maintain BUY with a target price of Rs 261/sh (20x Sep-21E EPS).