Hold Gujarat Gas, target Rs 150: JM Financial

JM Financial has given a hold recommendation on Gujarat Gas (GGL) with a target price of Rs 150.

Shares of Gujarat Gas traded at Rs 162.8 around 12:40 pm on 4 July, 2019. The brokerage has set a one-year horizon for the stock to hit the target price.

"We value GGL using DCF (WACC: 10.5 per cent, terminal growth of 2 per cent) based on Ebitda of Rs 4/scm and a volume growth of 5 per cent," said the brokerage.

Investment rationale

Price cut to offset volume growth
Industrial and commercial users account for approximately 70 per cent of the revenue for the company and this price cut will help sustain volume beyond FY20.

GGL had recently expanded the Morbi region capacity to more than 6.5 mmscmd (million metric standard cubic meter per day) on the back of the NGT order and the sudden surge in demand from Morbi ceramic industry.

Morbi volumes, in the past, have been volatile and since GGL gets approximately 70 per cent volume from industrial customers, this volatility is likely to persist and this sudden spurt in volume should be taken with a pinch of salt.

This proactive price cut will also prevent customers from switching to other cheaper sources of energy like Propane.

Beyond the existing circles
"GGL is likely to report an over 30 per cent year-on-year (YoY) volume growth in FY20 on the back of sharp increase in volume growth. Given this new higher base, we slightly cut our future volume growth from nearly 7 per cent to 5 per cent," the brokerage said.

"Further, given the higher volume throughput on the same infrastructure, we cut our Ebidta/scm from approximately Rs 4.25 to Rs 4/scm for long-term. This cut in Ebidta/scm would ensure that the company earns approximately 14 per cent on the gross block and also earns a reasonable marketing margin," the brokerage added.

PNGRB bringing competition in the CGD
Petroleum and Natural Gas Regulatory Board (PNGRB) has proposed a concept paper to arrive at transportation rate for CGD network and transportation rate for CNG for those networks that have reached end of exemption period. The paper proposes two tariff system – one for the pipeline system for compressed CNG and other for non compressed gas.

Key risks
As per the brokerage, Morbi region is still an essential part of the business and any volume fluctuation would have significant impact on the company valuation.

Additionally, sharp increase in input gas cost may take time to pass through to the customer and hence can result into stress in the working capital.