Gujarat Gas Company: Stepping On The Gas

The role of company managements in the performance of companies in the Indian equity markets is no mean one, and the kind of volatility Gujarat Gas Company (GGCL) had witnessed over the past year and a half vindicates the same. 

The reason behind the volatility was very simple. British Gas (BG) wanted to sell off its full stake and make and exit, but found hardly any takers for the same. In this scenario, the stock witnessed a steep fall. From the levels of Rs 400, the stock plummeted to below Rs 200. 

This clearly points at the fact that whenever the management is not confident, shareholders tend to avoid the counter. GGCL is a good example of this phenomenon. No wonder the stock remained under pressure, until finally the state-owned Gujarat State Petroleum Corporation (GSPC) bought over the BG stake in GGCL. Since then, the stock has stabilised on the bourses, bringing solace to its shareholders. 

However, not all questions of the shareholders have been answered yet. For example, what is the strategy behind GPSC buying out GGCL? The question of a strategic fit for the company is particularly relevant, as GSPC has a presence in all verticals, be it upstream, mid-stream or downstream. What are the growth opportunities for GGCL? What is the possibility of merger of GSPC’s downstream companies with GGCL? We have tried to look for answers to these questions by meeting the managements of the two companies.

GSPC & GGCL: A Strategic Alliance

Before jumping into the deep end of the strategic alliance, let’s try to understand what the GSPC group is and where GGCL stands as a subsidiary. With 53 domestic blocks and 11 international blocks, GSPC is engaged in upstream activities like exploration and production. Mid-stream, it has a presence in gas marketing, LNG terminals and the gas transmission business. Downstream, it has a presence in city gas distribution, CNG stations (GSPC GAS and Sabarmati Gas) and power generation. It also has various other segments like wind power, solar power, etc. 

As regards GGCL’s strategic fit in the group, there are a few points that the management has indicated. First and the foremost has been the strengthening infrastructure presence in Gujarat. Secondly, GGCL would provide a market for equity gas finds in India. Apart from that, it would act as a retail aggregator for the group’s regasified liquefied natural gas (RLNG) business. Another advantage comes in from the fact that GGCL would leverage GSPC’s pipeline infrastructure to capture new retail markets. GGCL also finds a place in GSPC’s gas distribution business, providing economics of scale here. 

Understanding The Business 

GGCL is a leading player in the industry. It is the country’s largest private sector gas distribution company in terms of sales volumes, currently distributing approximately 2.9 million standard cubic feet per day (mmscmd) of natural gas. 

As far as its business goes, the primary level is the sourcing of gas from the various sources like PMT (Panna- Mukta-Tapti), other indigenous sources and RLNG. Through this, it provides services to the residential, commercial, industrial and transport (CNG) segments. So, the company has multiple source gas portfolios, with 95 per cent gas sourced at market prices. 

With a diverse customer mix, different applications and alternate fuels, and operations in a highly industrialised area, it benefits from a good combination of volumes and value optimisation. In addition, the company has strong capital efficiencies which we would discuss in detail further in this story.

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Customer Profile

The company also has good sales mix. Between January 2013 to June 2013, the sales volumes from the industrial segment stood at 75 per cent, those from domestic was at 10 per cent and those from CNG at 15 per cent. The best part here is that its dependence on the industrial segment has declined since 2011. (See figure: Sales Mix By Volume %). Here the management has stated that GSPC is moving towards better margin volumes, and hence, the sales mix is getting richer.

Oil & Gas Price Forecast 

The management has provided a forecast on oil & gas prices, where it expects brent and RLNG prices to remain stable till 2017. However, what remains a concern is that the prices are expected to move up sharply on the domestic front. Many feel that this would impact the performance of the company and reduce its margins, considering that GGCL sources 50 per cent from domestic markets. 

The management, however, has clarified that though the domestic prices would rise in 2014, GGCL has a fixed pricing contract till 2019. It is true that there are some reset clauses, but the prices would not move above USD 6/ mmbtu. Hence, as international prices are likely to remain stable and the rise in domestic prices would not hit the company till 2019, we do not expect its profitability to get impacted. 

Domestic Demand-Supply Forecast

With regard to gas, a consistent trend over the past is of demand over-taking supply. This situation is not expected to change in any significant way. On the other hand, domestic production has been affected on account of various factors including pricing issues and declining gas exploration. This clearly shows that there are going to be significant imports going ahead. 

Put succinctly, sourcing of gas is expected to be a real issue going ahead, with increasing imports as domestic supply remains stagnant. 

Strategy Ahead 

The business strategy of Gujarat Gas can be bifurcated into three segments, viz. sustaining profitability, investing for growth and integration efficiencies. 

Sustaining Profitability 

The management has stated that to maintain profitability, it will focus on valuable segments, optimise the supply portfolio and manage costs. In terms of valuable segments, it explained that the company will aggressively pursue new industrial loads in viable segments and expand its CNG station infrastructure in its current operating areas. As regards optimisation of its supply portfolio, the management has commented that it would go for a multi-source portfolio to improve suply security.

Growth Opportunities 

On the growth front, the management has stated that while it is looking for organic growth, it is also looking for fresh bid opportunity in new areas. With regard to organic growth, it is focusing on unconnected zones in the current operating areas. However, we feel that the opportunities here are quite few, and hence, it would be looking for an integrated expansion model with industrial/CNG as anchor load. 

With respect to new bid opportunities, the company is looking for new geographic area addition via the Petroleum and Natural Gas Regulatory Board (PNGRB) route and has already participated in the third bid round. Apart from that, the management has plans to go even outside the boundaries of Gujarat.

However, there is a strict investment discipline, where it looks at an RoCE of around 17-22 per cent post tax. This clearly shows its intentions of opting for quality growth. GGCL has bid for the Bhavnagar district, as this seems to present a material near-term growth opportunity. It also provides synergy with existing businesses like proximity to the current area and financial synergy. 

PNGRB has identified around 300 new geographic areas, and we expect GGCL to benefit from its third bid round experience.
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Integration Of Efficiencies 

While the company is looking for opportunities, it is faced by another challenge of integration of efficiencies. The management seeks to leverage the group’s strengths and achieve synergy benefits. Here, GGCL would look to leverage GSPC Group’s pipeline infrastructure across the country. This would help the company achieve process and cost efficiencies. 

Now, this takes us to the most valid question. If there is good amount of synergy in the segments, what is the possibility of a merger between GGCL, GSPC Gas and Sabarmati Gas? In this regard, Tapan Ray, Chairman, GSPC Group shared that while the group is not looking for any merger activities in the near future, there would be some crossover of clients in some areas. But here too, it would look into the best possible options to serve clients at the minimum cost. 

While these efforts are already on, the company is expecting new volumes growth from the government’s industrialisation efforts. Recently, many major manufacturing groups (Maruti, Tata, etc.) have shifted to Gujarat, and this provides a good growth opportunity to GGCL. With the company going ahead with a higher share of RLNG in the supply portfolio, it would be able to grab the opportunities. The margins would be maintained, as any increase in cost of gas is directly passed on to its customers.

Concerns On The Horizon 

The first and the foremost concern from a near-to-medium term perspective is that the gas volumes will remain under pressure on account of the customer churn. However, the management is focusing on high margins clientele. From a long-term perspective, the critical factors are change in dividend payout, and expansion to newer geographies. 

Finally, the management is mulling rationalisation of dividend payout and there is a high probability of it being reduced in the time to come. This is a real issue, and more clarity on the same would certainly help.

Financial Performance

There are quite a few positives for the company on the financial front. First and foremost, its gross margins improved to Rs 8.60 per Std Cubic Metre (SCM) in Q2CY13 after dipping as low as Rs 2.30 in Q4CY11. As for the other parameters, its Q2CY13 results saw GGCC reporting revenues lower by 2.7 per cent at Rs 751.4 crore and PAT higher by 91.6 per cent at Rs 100.6 crore on a YoY basis. The revenues came in the below street’s estimates on account of lower volumes. 

During the quarter, the company reported its highest ever gross spread of Rs 8.60 per SCM. As already mentioned, the volumes decreased 9.5 per cent QoQ from 264 mmscm in Q1CY13 to 239 mmscm in Q2CY13. However, this decline was offset by the higher realisations.

As of the half year (H1CY13), the company has a topline and bo tomline numbers of Rs 1518.49 crore and Rs 160.18 crore as against Rs 1495.4 crore and Rs 118.05 crore respectively in H1CY12. We expect it to sustain its operating profitability going ahead and put in a topline of Rs 3200-3250 crore and a bottomline around Rs 310-315 crore. This would result in an EPS of Rs 24.20, which discounts the CMP by 9.2x. 

A Fruitful Union Indeed! 

We feel that the alignment with GSPC makes for better growth prospects for GGCL. Hence, we recommend that investors buy this scrip with a target price of Rs 295 over the next one year.