Mahanagar Gas stock slumps 16% from recent high; is it a good time to buy?

Shares of Mahanagar Gas (MGL) slumped 15% in the previous trading session to ₹1,329 apiece, and they are down 16% from a record high of ₹1,580 apiece. This sudden downturn occurred after the company reduced CNG prices to pass on benefits to end consumers. Investors anticipate that this move will likely impact the company's margins in the future.

In addition, global brokerage firm Citi has downgraded its rating on the stock from 'Buy' to 'Sell' and trimmed its target price to ₹1,405 from ₹1,480 apiece, which also impacted the investor's sentiment towards the stock. 

Amid this, domestic brokerage firm Nuvama Institutional Equities said the recent correction has provided a good opportunity to enter the stock. According to brokerage analysis, the stock is currently trading at 11 times the estimated earnings for FY25, representing a 26% discount compared to IGL's valuation of 15 times. 

Nuvama believes that Mahanagar Gas is poised for further appreciation, given its favorable valuation relative to historical averages, supported by robust demand and expansion into new geographical areas (GAs). Notably, MGL boasts a debt-free status, substantial cash reserves exceeding ₹2 billion, and a dividend yield of 3%.

Therefore, the brokerage maintains its 'buy' rating on the stock with a target price of ₹1,601 apiece. This target price suggests a potential upside of 20.5% from the stock's most recent closing price.

Also Read: Mahanagar Gas stock tumbles 16% to hit 6-week low after Citi cuts target price

Increasing competitiveness is expected to drive higher volumes

The company has recently implemented a reduction in CNG prices in Mumbai by ₹3.3 per scm ( ₹2.5 per kg), or 3.5%. According to estimates by Nuvama, a significant portion of this price reduction, approximately ₹1.7 per scm (51% of the price cut), is attributed to a 38% quarter-on-quarter decrease in input spot LNG (constituting 10% of the input mix), and the balance to a reduction in margins. 

Also Read: IREDA stock tumbles 32% from all-time high; is there more pain ahead?

MGL's current low-cost spot sourcing mix will increase to 10% (currently at 6%) as volumes continue to rise. Despite earning a margin of ₹13 per scm during 3QFY24, MGL's long-term guidance remains at ₹10.

MGL has demonstrated a willingness to reduce margins as volumes increase, as seen during Q2FY24 when margins were reduced by 9%, resulting in an 8% increase in volumes. Following the recent price cut, the competitiveness of CNG compared to petrol and diesel has risen to 50% and 35%, respectively (from 48% and 33%). This enhanced competitiveness is expected to further drive up volumes, as highlighted by the brokerage.

Monopoly in pipeline distribution to continue in perpetuity

The Petroleum and Natural Gas Regulatory Board (PNGRB) announced the end of MGL's monopoly in Mumbai on April 11, 2021. However, according to regulations, this monopoly can be extended for up to ten years, for which precedents exist in other geographies.

Therefore, the end of the monopoly is not a significant concern, says Nuvama, as marketing exclusivity resumes once any pending court cases are resolved. Moreover, the regulation clearly states that competitors cannot establish their own marketing at stations where MGL's dispensation is already installed. 

Also Read: 66 companies to see IPO lock-in expire in four months

This leaves less than 30% of outlets available for setting up gas dispensation—almost all likely to be ultra-low-output outlets. Besides, MGL would earn a 12% RoIC on the pipeline distribution for even the volumes sold by the competition. 

Overall, the barrier to entry for competitors remains high, with the potential impact on volumes being relatively insignificant, as indicated by Nuvama. 

Low penetration in GAs implies scope for growth

The low penetration levels in GA I and II, ranging from 35–40%, and in GA III, at 15-20%, indicate significant potential for growth in the upcoming years. According to Nuvama, Mahanagar Gas is expected to sustain its long-term volume CAGR of approximately 6%. 

Additionally, MGL has planned a capex of ₹7-8 billion for FY24E and FY25E, further highlighting its commitment to expansion and development, it added. 

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before making any investment decisions.