Gujarat Gas Company - Stepping on the gas

On Nov 8th 2011, the Berkshire headquartered BG Group Plc announced its plans of selling its stake in the Gujarat Gas Company (GGCL). Though the British exploration major did not decide on how much of its stake it would offload, initial media reports suggested that the parent company was mulling the option of diluting its entire 65% stake in GGCL if valuations are attractive.

The UK-based company had acquired GGCL in 1997 from the Gujarat Industrial Investment Corporation and Mafatlal Group at a total price consideration of Rs 170 cr. At the existing share value, if BG decides to do away with its entire stake, the deal should fetch the company around Rs 2900 cr.

As for GGCL, this development sent the stock crashing downhill, and it has lost more than 12%-15% of its value since the announcement. The negative sentiments on the stock were not only led by the worries over the impact of BG’s exit from the company, but also on concerns raised by the sharp depreciation of the rupee.

However, we at DSIJ, feel that the concerns surrounding to the stock are overplayed and unwarranted. We that suggest our readers should take another look at the company with a positive approach.

Our confidence in the stock stems from the company’s dominant position. GGCL is India’s largest private sector gas distribution company in terms of sales volumes, with its presence across various key industrial estates in Gujarat. Gujarat is the 2nd-highest industrialised state in the country, accounting for around 13% of the industrial output and consuming nearly 45% of the natural gas in India. Backed by an extensive 3900-km gas pipeline network. GGCL stands to highly benefit from the same. The company also stands to benefit from the Delhi-Mumbai Industrial Corridor (DMIC) project, which will boost the fuel and power demand in Gujarat (38% of the DMIC passes through Gujarat).

On the gas supply front, as 65% of the company’s sourcing is tied up till the year 2018, we believe that the impact of BG’s proposed exit on GGCL’s day-to-day business would be minimal. Also, keeping in mind the requirement of high-end expertise and technical know-how, the prospective buyer of BG’s stake is likely to have ample knowledge and supply arrangements in place. According to media reports, some major Indian corporates have shown keen interest in picking up the stake, and hence, we expect the bidding to be very aggressive.

It has also come to light that the upstream major GAIL, which has eyed an entry into Gujarat for quite some time, has been facing severe competition from Gujarat State Petronet. The signing of the RIL-BP deal for gas sourcing and marketing is only expected to heat up the competition. In this backdrop, GGCL, with its dominant position in the gas business, will provide ample growth opportunities and a competitive edge to its new owner.

On the company’s currency risk exposure front, the impact of the rupee weakening would be limited and temporary, as the company expects to hike its rates and pass on the cost to consumers to compensate for the same. In the previously concluded quarter, the company had hiked gas price for industrial customers by 44%. Similarly, it has taken a price hike of 22% in the CNG segment. We  also believe that the high volatility seen in the rupee/dollar movements in the recent past would die down eventually, thanks to some stringent measures taken by the RBI to restrict speculative trading.

On the financial front, the company has reported a robust 31% jump in its topline and a 41% rise in the bottomline in the 9M CY11 results. Sequentially however, the operating margins came under some pressure as a result of sharp rupee depreciation and a rise in LNG import prices. The company countered the same with some price hikes, and the effect of this can be seen in the improvement in margins on a YoY basis. At CMP of Rs 382, the counter is trading at 14.08x its annualised EPS of Rs 25.80.

In conclusion, though there are some near-term risks involved in respect of the lagging domestic gas production, higher winter LNG prices and a seasonally weak December quarter, we recommend buying the scrip at the current levels. This is on account of GGCL’s strong market position, the increasing demand for gas in the country, the bounceback of volumes to historic levels post winter and the govt’s growing impetus to using gas as compared to other fuels. Also, the company’s robust capex plans in order to increase its overall gas network to better serve the growing needs of the country will work as a key catalyst.