India focused Portfolio Advisory - Exp of 40+years, Das Capital Management and Advisors

Arun Thirumalai

India focused Portfolio Advisory - Exp of 40+years

Das Capital Management and Advisors

Das Capital is a research boutique with an aim to continuously map and plan the investment needs of investors focused on India. We have a six member research team with a combined experience of over 40 years as a part of our investment wing. Our team assisted in the setup of Premji Investments, which was one of India’s first family offices focused to managing Mr.Azim Premji personal wealth. We also serve as a research team to two Indian private equity energy funds “Small is Beautiful” and “KSK Emerging India Energy Fund”.

Equity Bottom-Up

Mahanagar Gas is the sole distributor of Compressed Natural Gas (CNG) and Piped Natural Gas (PNG) supplying CNG to 0.42 mn motor vehicles and PNG to 0.82 mn households in Mumbai and its adjoining areas. It is a joint venture between Government Of India controlled Gas Authority of India Ltd (GAIL) and BG group UK with each having 32.5% stake in the company.Growth drivers<ul><li>Under-penetrated market </li></ul>The company’s prospect looks attractive due to low penetration of CNG and PNG users in Mumbai region as these fuels are highly price competitive compared to other motor fuels and LPG.<ul><li>Favourable Regulatory Regime</li></ul>The Government has executed certain policies/orders for a cleaner environment which may benefit City Gas Distributors (CGD) like Mahanagar Gas.<ol><li>Government promoted City Gas distributors to priority status for getting government regulated natural gas</li><li>Supreme Court ordered auto manufacturers to pay a levy equal to 1% of the ex-showroom price of diesel vehicles with an engine capacity above 2000cc and also asked Indraprastha Gas Ltd, the CNG distributor in NCR region to add 104 outlets in Delhi.</li></ol>However, certain risks overshadow company’s growth prospect in the medium term<ul><li>Gas availability</li></ul>Lack of clarity on availability of natural gas at government regulated price is a major cause of concern. If the company resorts to procure additional natural gas at market price, it may impact its profitability as it may not be able to pass on the entire cost to consumers to remain competitive with other fuels.<ul><li>Market exclusivity </li></ul>Company’s market exclusivity for Mumbai and adjoining areas came to an end in 2014, but this order from the regulator Petroleum and Natural Gas Regulatory Board (PNGRB) is under litigation. Any adverse rule may affect its revenue growth as competition may arise.Outlook and valuationWe expect a muted growth of 2% CAGR in revenue at Rs.2150 Cr (USD 325mn) for FY18e. However, we expect 15% CAGR growth in EPS at Rs. 46.5/ share by FY18e due to reduction of government regulated gas price by 34% to USD 2.50/mmbtu since April 2016, which may improve EBITDA margin by 600 bps  to 32.73% in FY18e. However, our projections may be impacted if there is a turnaround in international gas price.The company trades at P/E of 18x FY17e EPS and 16x FY18e EPS and an EV/EBITDA of 10.6x FY17e EBITDA and 9.7x FY18e EBITDA which we believe is overvalued given significant risks that may play out<ul><li>An uncertain outlook for supply of government regulated natural gas</li><li>Uncertainty w.r.t  natural gas prices especially post the recent fall in natural gas prices and the fact that the company may be unable to pass on the entire cost of escalation. This could affect the competitiveness of natural gas as fuel, and effect companies volumes antd profitability.</li></ul>

Mahanagar Gas is the sole distributor of Compressed Natural Gas (CNG) and Piped Natural Gas (PNG) supplying CNG to 0.42 mn motor vehicles and PNG to 0.82 mn households in Mumbai and its adjoining areas. It is a joint venture between Government Of India controlled Gas Authority of India Ltd (GAIL) and BG group UK with each having 32.5% stake in the company.Growth driversUnder-penetrated market The company’s prospect looks attractive due to low penetration of CNG and PNG users in Mumbai region as these fuels are highly price competitive compared to other motor fuels and LPG.Favourable Regulatory RegimeThe Government has executed certain policies/orders for a cleaner environment which may benefit City Gas Distributors (CGD) like Mahanagar Gas.Government promoted City Gas distributors to priority status for getting government regulated natural gasSupreme Court ordered auto manufacturers to pay a levy equal to 1% of the ex-showroom price of diesel vehicles with an engine capacity above 2000cc and also asked Indraprastha Gas Ltd, the CNG distributor in NCR region to add 104 outlets in Delhi.However, certain risks overshadow company’s growth prospect in the medium termGas availabilityLack of clarity on availability of natural gas at government regulated price is a major cause of concern. If the company resorts to procure additional natural gas at market price, it may impact its profitability as it may not be able to pass on the entire cost to consumers to remain competitive with other fuels.Market exclusivity Company’s market exclusivity for Mumbai and adjoining areas came to an end in 2014, but this order from the regulator Petroleum and Natural Gas Regulatory Board (PNGRB) is under litigation. Any adverse rule may affect its revenue growth as competition may arise.Outlook and valuationWe expect a muted growth of 2% CAGR in revenue at Rs.2150 Cr (USD 325mn) for FY18e. However, we expect 15% CAGR growth in EPS at Rs. 46.5/ share by FY18e due to reduction of government regulated gas price by 34% to USD 2.50/mmbtu since April 2016, which may improve EBITDA margin by 600 bps  to 32.73% in FY18e. However, our projections may be impacted if there is a turnaround in international gas price.The company trades at P/E of 18x FY17e EPS and 16x FY18e EPS and an EV/EBITDA of 10.6x FY17e EBITDA and 9.7x FY18e EBITDA which we believe is overvalued given significant risks that may play outAn uncertain outlook for supply of government regulated natural gasUncertainty w.r.t  natural gas prices especially post the recent fall in natural gas prices and the fact that the company may be unable to pass on the entire cost of escalation. This could affect the competitiveness of natural gas as fuel, and effect companies volumes antd profitability.

Mahanagar Gas-Supply Side Constraint Obscures Growth Visibility