Gujarat Gas-Game Changer
Allocation of natural gas from KG6, Cairn's Mangalaya field‚ and licence to distribute gas in an additional three cities of Gujarat are a game changer for Gujarat Gas. Patient investors will reap the gains.
Company description
Gujarat Gas, a 65% subsidiary of British Gas, has a unique natural gas
distribution and transportation franchise in the industrial zone of the western
Indian state of Gujarat. The company's key asset is the Hazira Ankleshwar
Pipeline (HAPi), which connects the landfall point of Natural Gas from the
Western Offshore fields to the industrial townships of Ankleshwar and Bharuch.
The company buys gas from different sources - GSPCL, PMT, Niko, GAIL, and Cairn - and sells it to a mix of industrial, domestic and commercial, and CNG consumers in and around the cities of Ankleshwar, Surat, and Bharuch, earning a distribution margin.
Investment strategy
We rate GGas shares as Buy / Low Risk (1L), with a target price of Rs386.
Taking advantage of increased gas availability in Gujarat, GGas has
transitioned to a robust and sustainable business model over the past three
years. GGas is now a distributor and bulk trader of gas from being a niche
distributor of piped natural gas earlier.
Recent regulations are a significant milestone for city gas distribution in India, but are largely neutral for GGas as the company makes reasonable margins. Ggas̢۪ industrial / bulk consumers are currently supplied only c75% of their requirements due to lack of gas availability. Ggas is, hence, seeking gas from other sources and could be a beneficiary of KG gas.
The EGoM has allocated 5 mmscmd of KG gas for city gas distribution, and Ggas appears as a contender for a portion of this. We factor in 0.8 mmscmd KG gas from Aug and 1-1.5 over CY10-11. However,
uncertainty prevails on this given the current controversy surrounding eligibility for this and Ggas is consequently exploring other options for sourcing gas, such as R-LNG, given reduced spot prices.
Valuation
Our DCF-based valuation for GGas is Rs386, which is rolled forward to Jun-
10E. Our DCF assumes a WACC of 10.1% (beta of 0.6), four years of explicit forecasts, and a terminal growth rate of 3% thereafter. We prefer DCF to value the company given the utility nature of the business, which ensures steady cash flows. Discounted cash flows also capture the value of the business over a longer term, given the new investments being made in the business and the longer-term growth opportunity for the retail gas distribution business in India.
Our target price equates to a P/E of 14.5x 2009E and P/CEPS of 11.4x.
Risks
We assign a Low Risk rating to GGas shares based on our quantitative riskrating system, which tracks 260-day historical share price volatility.
Government/regulatory interference in gas pipeline tariffs could impact GGas' earnings. The gas business typically involves take-or-pay clauses and GGas' inability to sell gas contracted could lead to financial losses, while suppliers' inability to supply could lead to one-off gains.
Many of GGas' supply agreements are denominated in US$ terms, and therefore subject to currency fluctuation risks. Most of GGas' purchased gas prices are linked to market prices of fuels. Sharp fluctuations in gas prices which GGas is unable to pass on to its consumers could impact margins.
Delay in access to KG gas or‚ reduction of gas supplies from GAIL could impact margins and profits adversely. If any of these risk factors has a greater impact than we expect, GGas' share price will likely have difficulty attaining our target price. If market prices of natural gas come off sharply amid increased availability, GGas' margins and earnings could be higher than our expectations.
Nothing in this‚ article‚ is, or should be construed as, investment advice.
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