Gujarat Gas Company Ltd (GGAS) is the largest private city gas distribution (CGD) player in the country with strong parentage of British Gas (BG). Currently the company transports ~3.5mmscmd of natural gas in industrial cities of Surat, Ankaleshwar and Bharuch in Gujarat.

Presence in Gujarat’s industrial hub

With its network of ~3300kms pipeline and ongoing capex, GGAS has made a strong footage in the three high growth cities of Gujarat. High industrial growth rate and unsaturated demand of ~50% in these cities should lead to robust growth in future.

Ability to pass price hike

GGAS has shown immense strength in terms of passing gas cost hike to its customers. Despite increasing proportion of high cost LNG the company has been able to maintain its margins. In the last six months GGAS has taken price hike of ~16% in each segment.

Strong base to support future capex

Gujarat gas with parentage of British Gas, debt free balance sheet, cash & liquid investment of Rs4.1bn (CY10) and generation of cash flow from operation of ~Rs1.9bn per year bode for geographical expansion in future with increasing natural gas supply in India.

Concerns Negative INR-USD movement, uneconomical prices of LNG and any regulatory interference in deciding marketing margins may be negative for GGAS.

VALUATIONS AND RECOMMENDATION

At the CMP of Rs375, the stock trades at a P/E of 15.4x and 14.0x and EV/ EBITDA of 10.5x and 9.4x for CY11E and CY12E respectively. We initiate coverage on Gujarat Gas with ‘BUY’ recommendation and a price target of Rs465 based on DCF (upside +24%) on 12 month time horizon.

BACKGROUND

Gujarat Gas Company Ltd. (GGAS) is an Ahmedabad based largest private CGD player in India. GGAS was incorporated in Jan'80 as Gujarat Amino Chemical Ltd. In Jun'88, the company signed a JV agreement with Mafatlal Group for the purchase and distribution of natural gas to the industrial, commercial and domestic consumers in Gujarat. GGAS, in Sep'89, began operations in Ankleshwar and Bharuch in South Gujarat and expanded operations to Surat in 1990 where the company started India's first CNG station. In Sep'97, GGCL was acquired by BG Group (British Gas), following which the company entered into gas transmission business with focus on high margin CGD business. Currently GGAS operates in Surat, Bharuch and Ankleshwar (All Gujarat) and supplies ~3.5mmscmd of natural gas. The company sources gas from multiple suppliers including GAIL, Cairn, PMT and R-LNG and sells it primarily to retail industrial consumers through its pipeline infrastructure. GGAS being a subsidiary of BG Group (BG India holds 65% stake in GGAS), which is one of the largest gas utilities in the world, and has a presence across the value chain further adds to its strength.

COST BREAKUP

GGAS trades in Natural gas and hence takes title of gas transported. Therefore, operating cost accounts for ~80% of net sales with raw material cost being the highest component (~71% of sales). The NG procured on long term contracts is on a ‘take or pay’ basis and therefore constitutes as a fixed cost. Being a debt free company, interest cost is zero for the company.

INVESTMENT RATIONALE

Unsaturated demand in the current Market

GGAS enjoys exclusivity of supply to Surat, Ankleshwar and Bharuch. The CGD demand from these three cities itself is estimated at 6.3mmscmd, which is 13% of the total estimated NG gas demand in Gujarat, thereby making it – particularly Surat – one of the most attractive CGD markets in India.

Surat

The second largest city of Gujarat is an important industrial hub dominated by textiles and gems & jewellery industry. It is also home to large capital intensive industries at Hazira and a number of industrial estates. Due to rapid growth a number of commercial establishments have come up in the city. The estimated vehicle population profile includes 840 buses, 60,000 three wheelers and 1,50,000 four wheelers.

Volume growth with improving margins

GGAS with its approach of increasing the proportion of high margin customers (industrial retails) and ability to pass rising cost has been able to maintain its margins.

Healthy returns

Gujarat gas has been able to maintain its margins and returns despite challenges in sourcing gas and increasing gas cost. With right strategy in place and natural gas being a seller’s market we expect sustained performance going forward.

Expansion plans

Current Market: As mentioned in the beginning there is still an un-met demand to the tune of ~45% in GGAS’ current market i. e. Surat, Ankleshwar and Bharuch. Also as per current regulation, marketing exclusivity exist for three years after authorisation from PNGRB. To address the above issue, GGAS is regularly increasing its network in these cities. Currently it has a network of ~3300kms and the average capex incurred by GGAS is Rs1.5bn per year. Indirectly the company is creating its monopoly in these cities even after the end of marketing exclusivity.

New Market: GGAS has submitted EOI for Bhavnagar and Kutchch, combined expected to have potential of ~0.4mmscmd of natural gas. Apart from that GGAS should also bid for other Gujarat states EOI raised by other CGD players. The company’s status of being the largest CGD player in India and huge cash rich balance sheet augur well for new city addition as growth driver in the future.

Delhi –Mumbai Metro corridor (DMIC): Around 38% of DMIC is expected to pass through Gujarat. It will pass through the heart of GGAS current market, Surat and Bharuch district. Surat, the fastest growing city in India along with other Gujarat cities is expected to generate huge growth potential in future.

VALUATION

GGAS with presence in high growth cities in Gujarat and demand-supply gap should benefit with the incremental volume. We have considered risk free rate at 8%, market risk premium at 6% and terminal growth rate as 3% for GGAS post CY14 for our valuation.

RECOMMENDATION

At the CMP of Rs375, the stock trades at a P/E of 15.4x and 14.0x and EV/ EBITDA of 10.5x and 9.4x for CY11E and CY12E respectively. We initiate coverage on GGAS with ‘BUY’ recommendation and a price target of Rs465 based on DCF (upside +24%) on 12 month time horizon.

CONCERNS

Exposure to INR-USD movement: GGAS buys gas in USD and sells them in INR, thus exposing it to Rs-USD movement. GGAS has ability to pass rising cost to customers however, it can not be done frequently and hence company is exposed to exchange risk as they do not hedge against it.

CNG growth with franchise model: GGAS operates on franchisees model for CNG, which keeps upfront investment low, but reduces EBITDA margins (dealer margins will add to cost). The company usually signs long term contracts with its franchisees and believes that they are unlikely to go away after marketing exclusivity period. However, we believe this structure is always exposed to poaching risks.

Availability of gas: High demand and low supply of natural gas in India always pose risk for increasing availability of gas. Though, GGAS has multiple supply point and has BG as parent, however, situation like CY08 can’t be ignored when volume de-grew YoY due to sudden decrease in volumes from PMT.

Unfavourable policy – cap on marketing margins: Currently PNGRB has regulation in place for network tariff. However, marketing margins are unregulated and decided by companies. Any regulation for marketing margins may be negative for CGD players.