Indraprastha Gas: Buy

Investors with a long-term perspective can buy the stock of Indraprastha Gas, the city gas distributor in Delhi and surrounding areas of Noida and Ghaziabad.

The stock is down 20 per cent since last September, and at its current market price (Rs 358) discounts trailing twelve month earnings by around 17 times. This is lower than its historical valuation levels. Rising cost pressure due to higher proportion of expensive imported gas and a depreciating rupee more than offset volume growth and modest price hikes in the last two quarters.

This resulted in the company's margins and profits declining (on a sequential basis), and contributed to the stock's underperformance. Also, news in mid-January about a proposed cap on marketing margins of gas companies took a toll. These concerns may, however, be overdone.

The company's financial position is robust with debt-to-equity of 0.45 (as on September) providing room for leverage to fund expansion plans. Despite being under pressure, operating and net margins are still healthy at around 23 per cent and 10.5 per cent. Sales in the December quarter grew around 10.8 per cent sequentially to Rs 662 crore, thanks to higher volumes and price hikes. Profit though declined by 10.5 per cent to Rs 69 crore due to rising input cost and depreciation.

Volume growth

The company has taken additional price hike (around 5 per cent in CNG) in early January; the rupee has strengthened since the beginning of the calendar; and the cost of imported gas has moderated somewhat. These should alleviate some concerns on the margin front. Margins may not revert to erstwhile high levels (around 30 per cent at the operating level). While gas under the administered price mechanism (the cheapest source in the country) accounts for the bulk of the company's supplies, it also depends on imports and buys gas from other sources such as the KG-D6 fields of Reliance Industries.

Supply of the relatively cheaper KG-D6 gas to the company stopped in September, and Indraprastha Gas had to source costlier imported gas (spot cargo) to meet existing and incremental demand. This is expected to continue. But, despite lower margins, the company's sales and profits should grow on the back of robust volume growth.

Gas is more economical than other alternatives. This should help Indraprastha Gas grow business across customer segments — vehicle owners, households and industries.

In the December quarter, the company's CNG and PNG volumes grew around 16 per cent and 64 per cent over the same period the previous year. The sequential growth in overall volumes was around 2 per cent to touch 3.41 mmscmd.

The company expects to end FY-12 with volumes of 3.1 mmscmd which should further grow to 4 mmscmd in FY-13. To cater to the increased demand, Indraprastha Gas is expanding its network, and has planned a capital expenditure of Rs 2,200 crore in the FY-12 to FY-15 period. In the long run, an expected increase in domestic gas production and long-term contracts for imported gas should benefit the company. If the company wins its bids for setting up city gas networks in Ludhiana and Jalandhar, it will be an added boost.

Cap on margins

It is not clear whether city gas distributors such as Indraprastha Gas would come under the ambit of the proposed cap on marketing margins of gas entities. The company believes that the cap, if and when implemented, would not apply to it since it incurs expenses on the sourcing and marketing of gas. In any case, the process is likely to be long-drawn.

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