Stock Review: Indraprastha Gas

 

Started with the objective of supplying natural gas to New Delhi, Indraprastha Gas (IGL) has grown to become India's leading natural gas distributor. Now, in addition to Delhi, it also supplies gas to neighbouring townships such as Noida and Ghaziabad. Two large public-sector companies — BPCL with 22.5 per cent stake and Gail also with 22.5 per cent stake — are its main promoters while Delhi government holds a minor 5 per cent stake. At the end of FY10 IGL earned 86 per cent of its total revenue from the distribution of CNG to vehicles in Delhi and the NCR.

 

Strengths

Strong volume growth: Volume growth is the key driver of IGL's revenue. CNG sales touched a record high in Q2FY11 at 155.6 million kg while increased offtake from industrial customers boosted the sale of PNG. According to a recent Edelweiss report, IGL is expected to post volume growth of 24 per cent in FY11E and 19 per cent in FY12E.
Expanding network: IGL plans to invest approximately Rs 400 crore each in FY11 and FY12 to expand its presence in the NCR. As it expands its distribution network into townships such as Greater Noida, Sonepat and Panipat, its volumes are expected to rise.
Monopoly: It enjoys the first-mover advantage. IGL has built the pipelines required for distribution of natural gas. This network exclusivity will remain with IGL for another 25 years after the expiry of its marketing licence in 2011. This will handicap its competitors whenever they enter the markets where IGL is already present. Moreover, IGL gets gas from Gail under the administered price mechanism (APM) at a discount to the market price, hence it can to some extent undercut its competitors.

 

Risks

Inability to pass on price rise: As volumes rise, IGL will have to look elsewhere (besides GAIL) for meeting its demand. It will then have to buy gas at market price from suppliers such as RIL & BPCL. If it is unable to pass on these costs to consumers then IGL's margins will take a hit. Till now it has maintained a stellar operating margin of 30 per cent, but doing so in future may not be easy.
Increased competition: Heavyweights like RIL and Gail (its promoter) are set to enter natural gas distribution. Unlike IGL they will have the advantage of in-house gas supply and in the long run, they will be able to nullify it's first-mover advantage.
Run-in with regulator: IGL's exclusivity is being questioned by the new regulator, Petroleum and Natural Gas Regulatory Board (PNGBR). PNGBR relented when the courts intervened. But IGL's run-in with the regulator has the potential to hurt its chances of winning bids in other cities. PNGBR plans to call for bids for gas distribution licences in eight cities.

 

Valuation

In the past three years the stock has turned in a stellar performance — an annualised return of 49.47 per cent. As a result the current price of the stock is close to its three-year peak.
The stock is currently trading at a PE of 20.17 (December 2). This is much higher than its five-year median PE of 12.84. Over the last five years the stock's earnings per share (EPS) has grown at a compounded annual rate of 18.7 per cent. This gives it a price-earnings to growth (PEG) ratio of 1.08.
While the company's outlook is positive, valuations appear to be stretched. Buy only when the stock price corrects.