Mr. Harshad Katkar, Institutional Research Analyst, HDFC Securities & Mr. Nilesh Ghuge, Institutional Research Analyst, HDFC Securities

The town gas distribution companies (CGD) – Indraprastha Gas (IGL), Gujarat Gas (GGL) and Mahanagar Gas (MGL) – have suffered an exaggerated correction of around 14-28% from their peaks of the last six months due to (1) a sharp rise in the prices of APM gas and spot LNG; (2) reduced taxes on gasoline and diesel, which reduced tax arbitration for CNG; and (3) potential increase in dealer margins. Although CGD companies’ margins are likely to be squeezed in the near term due to higher LNG spot prices and the 10-15% allocation of cheaper domestic gas to domestic CNG and PNG segments , margins should recover after this temporary drop due to the price advantage of CNG over gasoline and diesel and domestic PNG over LPG. We expect strong growth in CNG volumes to continue as the highest price differential on record between CNG and gasoline / diesel drives faster CNG adoption / conversion.

Pricing power to cushion the impact of the rising cost of input gas: After a 62% revision to $ 2.9 / mmbtu in October 2021, we expect the price of domestic gas to rise another 37+% at around USD 4 / mmbtu in April 2022 (Table 6), based on the current trend in international gas prices. However, as historical trends show and supported by the highest ever recorded differential between the price of CNG and alternative fuels (Table 2), town gas companies should be able to pass on any increase in the cost of gasoline. domestic gas on consumers. The CNG-gasoline price differential has increased 38% to INR 54 (Exhibit 4) over the past 12 months despite the recent reduction in gasoline taxes by the government, providing some support for any potential hikes in prices. CNG price. Any increase in OMC dealer margins will almost certainly be passed on to consumers without negatively impacting margins.

At the current price of gasoline, diesel and CNG, we estimate the running cost per km of INR 5 for gasoline, INR 3.4 for diesel and INR 1.6 for CNG. The resulting current price advantage for CNG over gasoline at INR 3.4 per km (121%) and diesel at INR 1.9 per km (22%) is the highest on record.

Strong volume growth after unlock: Our channel check shows higher vehicle conversion to CNG, due to highest CNG discount on record compared to gasoline and diesel and government regulatory pressure to reduce pollution. Additionally, with the easing of travel restrictions across the country, aggressive penetration into existing areas, and the development of new geographies (GAs), we expect volume growth to remain strong, driving corporate profit growth. CGD companies. We forecast volume growth of 22/16/18% versus FY21-23E for IGL / GGL / MGL.

IGL is our preferred choice: we remain optimistic on the CGD space but prefer IGL over GGL, given its strong exposure to the CNG segment at 73% and that of MGL at 72% versus 17% of GGL’s overall volumes. Currently IGL / GGL / MGL is trading at 20.5 / 23.7 / 9.9x BPA FY23E. While on FY23E PER, IGL and MGL are trading at a discount of 12% from its 3 year average, GGL is trading at a premium of 49%. We are revising our EPS estimates by around 3-7% for fiscal 22-24E and target price (TP) by 7-9%, given the short-term pressure on margins. We reiterate BUY on IGL with a TP of INR 665 based on (a) robust volume growth at 22% CAGR on FY21-23E, (b) stable margins and (c) government regulatory support to reduce pollution in Delhi / NCR region. We reiterate our PURCHASE rating on GGL with a TP of INR 790, due to ramping up volumes of existing and new GAs. We maintain ADD on MGL with a TP of INR 1,025, given the moderate volume growth over the long term.