IGL v/s Gujarat Gas: The better bet

City gas distribution (CGD) companies have enjoyed enormous investor confidence in the last few years, consistently beating the Sensex (Indraprastha Gas and Gujarat Gas have offered average annual growth rate (CAGR) of 26% and 28% respectively w.r.t to the markets) in the last four years. The sector seems set to benefit from relatively under penetrated markets (gas consumption accounts for just 9% of Indian energy matrix versus 23% globally). The city gas distribution story has many facets- regulations , infrastructural aspects, gas supplies, pricing and the business economies. The country is perennially short of energy supplies in comparison to its needs. With 70% dependence on substitutes like oil imports and inadequate coal supplies, the natural gas seems to be the answer to India's energy woes. This makes the city gas distribution story look promising. The companies that are playing the key roles here are the likes of Indraprastha Gas (IGL), Gujarat Gas (GGAS), Mahanagar Gas and Gujarat State Petroleum Corporation Gas (GSPC Gas) that control 84% of the CGD market volumes. These are the companies that procure gas from suppliers like Gas Authority Of India Ltd. (GAIL), Reliance Industries Limited (RIL) and transport it through their pipeline network to the end users - the industrial and retail users. Among the four key players, we will compare GGAS and IGL - the two players that have lost 23% and 16% on the bourses since their September 2011 peak.

Let us start with the basics of the two companies

The 'Promoter's premium'

IGL's promoters are Bharat Petroleum Corporation Ltd. (BPCL) and GAIL, each having 22.5% stake in the company. Having backing of strong players like these makes the availability of imported gas more secure, without compromising its access to domestic gas supplies at subsidized prices. Gujarat Gas, which has in the past enjoyed 65% promoter stake of BG, however, seems to be losing in this regard with the recent announcement of stake sale by BG. While GGAS has more than 65% of gas sourcing already tied up by way of long term supplies (2018), the potential new supplies and even the bargaining power while making spot purchases is something we expect to suffer as a result of this event. The GGAS stock took a hit of 6% immediately after the announcement. However, with lot of potential suitors keen to own BG's share, the company may face aggressive bidding, thus firming up the stock price.

The 'Operational' factor

Both IGL and Gujarat Gas are leading players in City gas distribution segment. However, there is a stark difference in the category of clients they serve. While Gujarat Gas predominantly serves regions in Gujarat, IGL operates in NCR. Around 80% of Gujarat Gas' client base comprises of industrial customers and 10% comprises of Auto gas, unlike IGL which has key focus on supplying CNG for public transportation (80% of its business) and 10% to the industrial customers.

This makes a difference when it comes to the wiggle room available to hike prices (which in turn is a function of price of substitute fuels). For IGL, diesel and petrol are the key substitutes (of auto gas) that are approximately 52% and 23% costlier than CNG. For Gujarat Gas customers which are mainly industrial, the key substitutes are fuels like naphtha that are around 30% costlier than natural gas.

More on pricing...

IGL has 75% - 80% sourcing from domestic gas while Gujarat Gas' gas supplies are reliant on imported gas to the extent of 30%-35%. This makes Gujarat Gas less attractive in terms of margins. This is because there is a huge pricing differential between the domestic and imported gas. While the pricing of domestic gas varies between US$ 4.2 to US$ 7 .2 per MMBTU, the imported gas costs between US$ 10 to upto US$ 18 per MMBTU, depending upon whether they are procured under long term contracts or have been sourced on a spot basis. While both the companies have consistently increased gas prices, it will be a little harder for Gujarat Gas to continue the same in the future without impacting the volumes of gas sold. It is important to note here that Industrial segment is the most lucrative segment for any CGD company. However, the advantage for GGas is limited going forward since the regions in which it operates remain well supplied thus limiting the potential for price hikes. Gujarat Gas has already faced trouble in this regard as the textile industry and CNG based autos in the regions of Gujarat went for an indefinite strike in wake of price hikes in the current year.

While IGL has increased its prices by 50% in last two years (latest hike in October), Gujarat Gas has done the same by 40%.

To summarize, both the companies enjoy being the market leaders in their own regions. However, with the shortage of domestic gas supplies, the future performance will depend on how well they are able to maintain volumes without sacrificing margins - both on account of increasing share of the costlier imported gas and ability of the companies to pass price increases to end users.

In the next article, we will focus on the financial aspects of both the companies.