Gujarat Gas: Stepping on gas

If you look at the statistics of energy demand and supply in India, one fact comes out quite clearly: The energy hungry Indian economy would be increasingly relying on natural gas to power its growth engine. Take the power sector, for example. Power accounts for 40% of the natural gas demand in India. Natural gas, which currently accounts for 10% of the total power generation in India, is estimated to account for 20% of power generation by 2031-32. The overall gas demand is expected to rise from 179.17 MMSCMD in 2007-08 to 279.43 MMSCMD in 2011-12 and further to 682 MMSCMD by 2031-32. The Indian natural gas market is constrained by supply. Increased supply from the recent gas discoveries will result in realization of the full potential of natural gas, as a source of energy.

For Indian investors, then, it makes sense to participate in this booming sector. However a closer look at the companies operating in this field leaves you confused. The regulatory factors, subsidies, vertical integration of the large players, and the uncertainty about the quantum of gas find and production schedules, make the larger players in this sector (RIL, GAIL, etc) quite difficult to analyze. If you have to find easy bets, zoom in on gas distribution.

Gas Distribution is the process whereby gas is taken from the high pressure transmission system and distributed through low pressure networks of pipes to industrial complexes, offices and homes. This sector is much less commoditized as compared to Gas Transmission. Imagine an industrial area where a company sets up a gas distribution network. For this company, the addition of a new customer in the same area requires very little investment because the distribution network is already there. This network effect helps the early movers in this field to remain entrenched and get a better return on the invested capital. Gujarat Gas, which supplies gas to industrial units in Gujarat, earns 26% on its networth. Indraprastha Gas, which distributes city gas distribution in Delhi earns 30.3% on its networth. Given that the growth of gas distribution has been hitherto constrained by the supply, the recent gas discoveries in India are going to ease the supply scenario and growth is going to pick up in the coming years. All these factors make these businesses very attractive to long-term investors.

Among the companies I mentioned, I like Gujarat Gas a lot. Gujarat Gas Company Limited, (GGCL), a subsidiary of BG Group plc (65.12%), currently distributes approximately 3 mmscmd of natural gas. GGCL continues to be India’s largest private sector gas distribution company. It has a proven expertise in distributing gas to the entire range of customers – bulk industrial, retail industrial, commercial, domestic, and compressed natural gas (CNG). GGCL distributes gas to over 230,000 industrial, commercial and domestic customers and 73,000 CNG customers through a pipeline network of approximately 2,100 kms.

To gauge the attractiveness of the business you need to look into the balance sheet of company. As of Dec 31, 2007, the company has a networth of 587.5 crores and it is debt free. It grossed revenues of 1,262 crores and earned 152.9 crores in profits. A closer look leaves you wondering how the company generates 2.14 rupees worth of sales on every rupee of networth? How does the company operate with a negative working capital (-64.4 crores in FY 07)? The answer lies in the volume of ‘customer deposits’. A customer has to deposit money with GGCL to get natural gas. These customer deposits add up to 111.9 crores (FY 07), which makes 15% of the invested capital. This helps the company to scale up its business without diluting equity.

If all this is true, why is the company selling at a reasonable price of Rs 255.25 (on Aug 14th, 2008), 10 times its earning per share? The reason is a short-term problem in securing gas supplies at attractive rates. As per a news report, the company’s sales volume has fallen nearly 25% to 2.8 MMSCMD compared to the corresponding period in 2007. Adding to the problems, the cost of procurement has increased by 15 per cent. In my opinion, these factors are temporary. In the current year, the company is investing in network infrastructure to enable it to receive gas from the Krishna Godavari Basin, from 2009 onwards. Apart from these, LNG terminals are coming up all over the Gujarat coast line, which will help the company procure imported gas.

The company is rebalancing its portfolio to increase its share of revenues from the retail customers. The bulk industrial segment, which contributed 76% of the total sales volume, contributes less than 25% of total volumes now. It is expanding in the CNG segment. In the quarter ending June 30th, the CNG segment grew by over 28% with sales of 21 MMSCM, as the conversion of cars to CNG crossed 2,000 units per month. The company has achieved one of the highest penetration rates in the country in this segment. Every car converted into CNG brings in additional assured revenue to the CNG retailers like Gujarat Gas. With the fuel prices moving higher every year, the CNG sector is seeing lots of action with GAIL and RIL applying for licenses for CGD and CNG projects in 58 cities across the country.

Piped natural gas (PNG) is another growth area for the company. For a household consumer it is very convenient to use PNG in place of gas cylinders. In the industrialized world, PNG is a preferred way for transporting cooking gas to the end consumers. GGCL supplies PNG to 200,000 domestic households and it is rapidly increasing its user base.

On the valuation front I would have liked it cheaper (…but then I like all stock cheap). A price at three times the book value prevents me from going all-in into this stock. The relatively fair valuation makes it hard to get unfairly high returns, but then, given the uncertainties involved in other stocks, I find it a good value investment and expect the stock to give me above average returns in the long term.

You want the upside and downside targets? Sorry… wrong question at the wrong place.


Dimple Bakhda said...

Hi Kamlesh,

Great analysis as always.

Wont you put GGCL in the utility segment??? Is that the reason for your holding back All-in approach??

Keep writing... Spread the fire...

Warmest regards.


Kamlesh Pandey said...

You are right that GGCL is in the utility segment. If valuations are cheap I don't worry for that. In past I have made good returns by getting into commodity stocks 7 years ago, in the days when everyone was investing in IT.

My measured approach is a result of valuations. I want to invest in great businesses but I want them cheap, cheap and really cheap. if you wait long enough, you do get moments where you get good bargains. Till that time, invest but avoid going all-in.

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