IGL Returns....

IGL Returns…..

The name may sound like a movie sequel but there is a difference. Most movie sequels I have seen are not as good as the original. But the IGL story – a negative one as per my last blog (it had multiple villains, a teary storyline and no hero!), is likely to be better in the sequel.

Need for the Sequel

The reason for the rise from the ashes kind of story line for this company is some recent developments.

First: an affidavit was filed a few days ago by the Ministry of Petroleum and Natural Gas, which supported the stand of the marketing companies, including that of IGL, that PNGRB is not empowered to fix or regulate the maximum retail price (MRP) at which gas is to be sold by such entities.

The affidavit also clarified that the board is not empowered to fix any component of network tariff or compression charges for any City Gas Distribution (CGD) entity, the argument which was upheld by the Delhi High Court last year.

Stating that various provisions of the PNGRB Act, 2006, read with the policy are “unambiguous”, the ministry said: “Regulatory oversight over marketing and sale of notified petroleum products and natural gas would include enforcement of retail service obligations and marketing service obligations by the board. However, the Board is not empowered to fix the price at which the entities will market or sell notified petroleum and natural gas. The MRP is to be fixed by the entity. The board shall monitor prices and take coercive measure to prevent restrictive trade practices by the entities.” 

This is no different than what IGL and other Gas distributing companies had been stating all along!

It may be recalled that the Delhi HC order had been given in response to IGL’s plea challenging an order from PNGRB to cut it’s network tariff by around 63%. PNGRB also fixed CNG compression tariff at Rs 2.75 a kg against Rs 6.66/kg charged by IGL. The implementation of the order would have drawn the curtains on IGL’s finances (and that of similar companies).

With the latest development, in my view the probability of the SC upholding the Delhi HC judgment has increased manifold. Indeed, the PNGRB’s appeal to SC itself may have lost its sting. 

Recall that the PNGRB had gone to the SC challenging the Delhi HC order, and the SC had asked the Government to clarify on the powers of PNGRB.  With the creator of the law (Government) clarifying that PNGRB has no role to play in the price fixation, the criteria upon which the SC would base its judgment has become simpler.

The judgment, once given (and if in favor of IGL), should shoo away the major cloud hanging over IGL’s valuation.

Second: the other major development on this stock is the one relating to the increased pricing of the APM gas.  The Government recently took that decision too and the price was hiked from $4.2 to almost double (over $8.2).  Ordinarily that should have scared investors.  Not so.

In my view, this was a significant step taken by the Government towards ensuring the country’s energy security as also towards ensuring lower outflow of Foreign Exchange, given India’s reliance on imported fuel including Gas.  A higher price ensures better profitability for the E&P companies, making it more remunerative for them to make the required investments to search for Gas within the Indian shores.  Medium to long term, a great bit of news for the industy.

As far as companies like IGL are concerned, the best thing is that unlike the PNGRB order, the APM price increase order hasn’t sprung up on them as a surprise.  Rather, the new higher Gas price is applicable only from April 1, 2014, giving enough time to them and the entire sector to adapt.

So…

Story line sans the suspense

What does that do to the prospects of IGL?  Recall my previous blog wherein I had stated the 3 main causes of worry over IGL.  2 of them (SC appeal and APM gas pricing) have been solved and the 3^rd one (marketing margin) wasn’t a great worry anyway as PNGRB never looked keen on pushing in that direction. In fact the latest Government affidavit also seems to have cleared the lack of clarity on that front.

Meanwhile, for doubting Thomases like me, the deteriorating Rupee too had become a cause of worry – not so much because the company is unable to pass on the additional cost to the consumer, but because with every rise, the price arbitrage that CNG had with Diesel, was fast disappearing.

Just to recall, the following is how it looked for the company as regards the costing and margins:

- APM gas is ~68% of the total gas requirement

- Total blended cost of gas is around Rs 17-18/scm and EBIT is around Rs 5/scm

- APM gas costs ~ Rs 11/scm and LNG is around Rs 32/scm (hence 68%*11 + 32%*32 = ~17-18) 

- Doubling of the APM gas component will move the cost up by Rs 7-8/scm (68%*11*2 + 32%*32 = 25 compared to earlier cost of Rs18). This would translate to an increase in the selling price of CNG by 11-12/kg.

The existing price of CNG in Delhi is around Rs 42/kg.  Hence an increase of Rs 11/kg would take the CNG at par with Diesel (Diesel is also being hiked regularly by Rs 0.45 per month).

True.  However, the interesting aspect is that the existing conversions from Petrol cars to CNG, are still continuing at the rate of 4000-5000 cars per month.  Ergo, this shows that CNG continues to hold its appeal as an alternative to Petrol if not against Diesel.

Besides the cars, the ‘captive business’ – commercial vehicles, buses and auto etc., which have no option but to run on CNG will continue providing the ballast to the CNG business. 

As a matter of fact, this part of the business is expected to get a fillip from a large number of new bus acquisitions by both Delhi Transport Corporation (DTC) and Delhi Integrated Multi-Modal Transit System (DIMTS). As compared to an addition of only 400 buses in FY13E, DIMTS and DTC are likely to add more than 3000 buses in FY14 as per independent analysts who have met the managements of the two organizations.

Additionally, as against the Supreme Court mandate (Nov’11) of adding 45K new auto rickshaw permits, the actual addition has only 5K.  Now, the Delhi Transport department is running with a target to add at least 10K permits p.a. over next couple of years. A larger figure was also confirmed in an interview with Rajiv Bajaj of Bajaj Auto, the premier supplier of Autos.

And of course there is PNG, which is almost an annuity business given the stickiness of demand, especially that of households.  The company continues to do major investments on laying pipelines and other infrastructure to provide PNG to the end customer.  Just to provide a perspective, IGL has only 400,000 PNG customers in a market size of 4 million LPG customers – all potential converts to PNG given the economic dynamics of PNG vs LPG (in the new dispensation). The only thing holding back the company from connecting the whole of Delhi by PNG is the plethora of regulatory/ bureaucratic approvals from local agencies as well as own capacity to implement.

What the above implies is that the volume is undeniably available – let us assume that the volume growth will be anywhere from 10%-15% over the next few years.  That’s a position many companies would love to be in.

What about the implication on volumes once APM gas price is doubled?  As I have elaborated above, much of the demand for CNG (buses, autos etc.) is inelastic.  The other part of the demand (cars and PNG) still finds this economically more advantageous than the alternative (Petrol/ LPG).  In fact in many places including in Gujarat and even nearby Meerut etc., the selling price of CNG is ~Rs 60 (compared to the existing price of Rs 42 in Delhi and Rs 52-54 even after the eventual doubling of the APM prices).  This proves that the market is willing to pay a higher price for the product.

What else could go wrong?  Could APM gas allocation to IGL be reduced or removed given the pressure over the Government to allocate more gas to the Fertilizer and Power industries?  Little chance of that in my view, given that City Gas distribution companies like IGL are not major users of APM gas anyway.  But in any event, the most such an event could do is make the selling price to around Rs 60 – a price at which as I have mentioned above, there is continuing demand.

Furthermore, logically speaking, the Government’s efforts in propping up the Gas potential of India by increasing the gas prices as well opening up the Shale gas policy should result in more gas in a couple of years – hopefully at prices that are lower than today.  Why?  Because in my view, fillip to the gas exploration efforts all over the world will make gas prices fall (they already are) and also because India will be less exposed to the vagaries of Foreign exchange fluctuations, given the localized production.  That really augurs well for the medium term prospects of the company.

Action!

With this, we can focus more on the normalized valuation of the company as opposed to figuring out the ifs and buts of uncertain items like court judgments and input pricing.

The current valuation of the company is at ~6X cash flows (EV of ~4000 cr. and a cash flow of ~600 cr.).  For a company which has such a fine business model, a monopolistic and large market, a good management as well as pricing power, wouldn’t you give at least a valuation of 10-12X cash flow (even in these troubled times)??

If the answer’s yes, then this would value the company at upwards of Rs 6000-7000 cr., providing a minimum 50% upside to current levels.

IGL returns, the sequel is likely to provide good returns from IGL! 

And that’s my kind of movie…