Shares of Indraprastha Gas Ltd (IGL) and Mahanagar Gas Ltd (MGL) have slipped 7% and 10%, respectively, in the first three trading days of this week, after the US and Israel attacked Iran over the weekend.
Both city gas distribution (CGD) companies derive almost three-fourth of their sales volume from compressed natural gas (CNG) that competes with other auto fuels (petrol and diesel).
Even if auto fuels are priced similarly to CNG, the latter still offers the advantage of being relatively clean and more efficient, with 15-20% higher mileage. But things could change due to the Iran conflict. Global crude oil and natural gas prices have now spiked, lifting prices of auto fuels and CNG.
However, the threat to CNG prices is higher as natural gas availability itself could become an issue. Qatar, a big supplier, has halted liquefied natural gas (LNG) production. On the other hand, the supply of auto fuels may continue as Russia can supply crude oil to India.
Margin call
Higher oil and gas prices should force CGDs and oil marketing companies (OMCs) to raise prices of CNG and auto fuels. Nomura estimates that CGDs source 30%-40% of their natural gas requirement from imported LNG. As imported LNG prices rise (due to higher pricing and shipping costs), CGDs must raise the CNG price to maintain their Ebitda margins. But CGDs can afford to raise CNG prices without losing a competitive edge, only if OMCs increase auto fuel prices. Ebitda is short for earnings before interest, taxes, depreciation, and amortization.
Private companies such as Reliance Industries Ltd and Nayara Energy may increase auto fuel prices, but state-owned OMCs may not be allowed to do so easily, as it is a politically sensitive matter. If OMCs do not hike prices, auto fuel volumes could gain at the expense of CNG volumes. If CGDs absorb higher costs, then Nomura estimates IGL and MGL’s Ebitda to drop 22% and 15%, respectively, for every 10% increase in imported gas costs. Both companies derive about 25% of their sales volume from piped natural gas (PNG) that competes with liquified petroleum gas (LPG).
The PNG segment faces limited threats to volume and margins as CGDs receive natural gas under an administered pricing mechanism (APM) in the domestic market at a lower rate than imported natural gas. Thus, IGL and MGL investors face a near-term worry about customers switching over to auto fuels. However, if the ongoing conflict prolongs, state-owned OMCs will have to consider raising auto fuel prices.
For now, valuations are not demanding. IGL and MGL both trade at a price-to-earnings multiple of 10x based on a Bloomberg consensus estimate for FY28.
To be sure, IGL and MGL’s earnings are relatively more cushioned than rival Gujarat Gas Ltd, which has high exposure to industrial customers. Interestingly, Gujarat Gas’s shares gained 2.5% over the first two trading days of the week. The Street’s initial positive reaction could be due to the expectation that industrial customers using propane may switch to natural gas due to LPG supply disruptions. That might provide some respite, but it won’t be enough.
In fact, Nomura estimates Gujarat Gas’s Ebitda to drop by 27% for every 10% rise in imported gas costs. On Wednesday, after market hours, Gujarat Gas announced that it has issued force majeure notices to its industrial customers, restricting supplies from 6 March. Consequently, on Thursday, Gujarat Gas stock gave up the gains seen earlier this week.