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Indraprastha Gas BUY - Quality play on gas retailing
Indraprastha Gas (IGL), the sole distributor of gas in the
National Capital Region (NCR), has extensive network
penetration. This, we reckon, will enable it to maintain its
monopoly in Delhi and pass on any increase in input prices, as
reflected in the 32% increase in CNG prices since June 2010. IGL
plans to replicate its network in markets adjoining Delhi—Noida,
Greater Noida and Ghaziabad—where demand for gas remains
strong. This, we reckon, will translate into a volume CAGR of
23% and earnings CAGR of 18% over FY11-13ii. Trading at 15x
FY12ii EPS, IGL offers a quality play on gas retailing in India.
Monopoly in the high-growth Delhi market: IGL’s gas
distribution network in Delhi (2,300km of pipelines + 241 CNG
stations), is hard to replicate, and is thus unlikely to face competition
in the near future. Given that CNG is much cheaper than liquid fuels,
we expect demand to remain firm, and forecast a volume CAGR of
13% through FY11-13ii. Furthermore, launch of CNG variants by
leading car-makers (Maruti, Hyundai, etc) could increase the
monthly rate of CNG-using private vehicles from ~4,000 in 1QFY11.
This presents an upside risk to our estimate of volume growth.
Growth beyond Delhi would support further volume growth: IGL
plans to replicate its gas retailing network in Noida, Greater Noida
and Ghaziabad, where latent demand remains strong (we estimate it
at 2-3mmscmd). Such sales could grow at an exponential rate and
account for 24% of sales by FY13ii and 28% by FY15ii. Over the next
few years, the government plans to appoint CGD (city gas
distribution) operators across 200 cities through a bidding process,
which presents a further growth opportunity to IGL.
Play on emerging gas retailing business in India—BUY: Our
estimate of 18% earnings CAGR for IGL through FY11-13ii builds in
23% volume CAGR, and assumes continuance of pricing power, which
is demonstrated in the series of price hikes taken by IGL in FY11 (CNG
prices up 32% YoY). IGL’s valuation of 15x FY12ii EPS is attractive, in
our view, and is at a discount to regional peers’ multiple of 15x-20x
one-year-forward earnings. IGL offers a long-term play on the
emerging gas-retailing business in India, which we believe is set for a
massive take-off. We retain BUY with a target price of Rs400.
Investment thesis
Monopoly in the high-growth Delhi market
Thanks to the regulatory push—mandatory conversion of all public
transport vehicles to compressed natural gas (CNG) from liquid fuels,
and rapid penetration of CNG-dispensing stations across Delhi—
almost ~0.4m vehicles (private + public) currently ply on CNG.
Conversion of vehicles to CNG has also been spurred by attractive
pricing against traditional liquid fuels. For instance, per-km cost of
running a CNG vehicle is 63% and 23% lower than that of a
comparable passenger vehicle running on petrol or diesel,
respectively
�� DTC bus fleet growth of 20%: Delhi Transport Corporation
(DTC) had ordered 3,500 new passenger buses to handle the
increase in traffic during the Commonwealth Games. It also plans
to phase out approximately 1,000 old buses, resulting in net
addition of 2,500 to DTC’s bus fleet and translating to an increase
of 20%. This in itself would add to CNG volumes from 2HFY11
onwards. IGL has signed a long-term contract with DTC, whereby
IGL would be the exclusive supplier of CNG to all DTC buses for
ten years.
�� Rapid increase in radio taxis: The Delhi government
introduced the first batch of “radio taxis” (call-a-cab service) in
the capital in 2006. The service has been gaining popularity
among business and leisure travellers. Since its launch in 2008,
the fleet has grown to ~3,000. This fleet is likely to be expanded
by 2,500 cabs in FY11, and by a further 2,500 in FY12, in
response to the growing popularity of these cabs. This bodes well
for CNG volumes.
�� Mandatory conversion of LCVs to CNG: The Delhi government
has mandated all LCVs registered and plying in Delhi to operate
on CNG. As of March 2010, Delhi had about 20,000 registered
LCVs, which can potentially operate on CNG. However, since the
mandate excludes carriers with national permits (which form a
large chunk of the overall population), we do not think these
conversions will result in a significant pick-up in the CNG
population, and assume ~200 conversions a year.
�� Rapid growth in PNG connections: Although IGL has a
presence in 55 of the 77 charge areas in Delhi, its network
remains under-utilised. The company currently supplies PNG to
only ~0.2m households, though it is equipped to supply to 0.6m
households. This is partly because the company has so far
concentrated on growing its CNG business, in which it enjoys
better pricing power.
However, with intensifying competition, IGL plans to improve
utilisation of its existing network by offering more connections to
domestic consumers. Over the next three years, IGL plans to
double its PNG connections from 0.2m to 0.4m.
In addition, IGL is focussing on the industrial and commercial
segment, where it expects an annual growth of 15% for the next
three years. The company has recently signed contracts to supply
gas to Hotel Leela for its new property at Chanakyapuri. In
addition, it will also supply almost 0.03mscmd gas to a 3.5MW
power plant at Thyagaraj Stadium, one of the venues of the
Commonwealth Games that were concluded in October 2010. The
plant may continue to operate after the Games thereby supplying
power to the neighbourhood.
�� Deregulation of administered petroleum products prices to
also drive volume growth: Complete deregulation of petrol
prices and partial deregulation of diesel (complete deregulation is
expected in phases) has resulted in a 22% increase in petrol
prices in Delhi. This increase in motor fuel prices has further
increased the per-km price difference between these liquid fuels
and CNG, making CNG conversion an even more economically
compelling choice.
Also, post the 12% increase in LPG prices, IGL too has increased
its PNG prices. The company has introduced differential pricing to
offset the impact of higher prices on low-gas-consuming
domestic consumers. IGL has increased prices of domestic piped
gas by ~19% (Rs18.95/scm) to consumers that consume 90scm
(equivalent to ~4 cylinders), in four months. And for consumers
that consume more than four cylinders in four months, the
applicable price increase is 23% (Rs26/scm).
��
Competition unlikely to shake IGL’s bastion in Delhi
Since its incorporation in 1998, IGL has enjoyed a monopoly.
Prospects of this monopoly continuing undisturbed came under a
cloud in 2006, when the government set up the Petroleum and
Natural Gas Regulatory Board (PNGRB) to steer development of CGD
(city gas distribution) operations across India. The primary
objectives of the board are to establish a regulatory framework,
regulate pipeline tariffs, introduce competition, and develop the
market. The board’s guidelines are applicable to PNG operations, but
CNG operations remain out of the regulatory ambit.
PNGRB has allowed a period of exclusivity for the companies that
were functional prior to its incorporation. Once the exclusivity period
ends, these areas would be open to competition.
The board has given IGL marketing exclusivity in PNG till January
2012, and network exclusivity till 2025. Thus, IGL will remain the
sole distributor of PNG in Delhi till 2012. Thereafter, other players
will be able to market PNG using IGL’s infrastructure, for which IGL
would receive a fixed charge (network exclusivity). The new entrants
will be allowed to develop their network only in areas where IGL
does not have its infrastructure in place.
In our view, IGL’s operations would remain unaffected by such
competition, as: 1) it has established a wide network in Delhi that is
hard to replicate; 2) it has set up this network at costs that are
substantially below the current setup costs; and 3) stringent
regulations that disallow duplication of the network will significantly
reduce operational flexibility for any new entrant.
IGL’s network reaches almost 75% of Delhi
Over the past ten years of its operations, IGL has built a pipeline
network spanning 2,300km across Delhi. The network covers 55 of
the 77 charge areas (as defined in the Delhi Master Plan). With an
aggregate compression capacity of 2.91m kg/day, IGL has the
second-largest CGD network in India. In addition to its widespread
network, IGL has the highest number of CNG dispensing stations in
India (241 as of FY10).
PNG retailing requires widespread penetration of the pipeline, while
the CNG business demands presence in key city locations. IGL has a
widespread pipeline network, and its 241 CNG stations across Delhi
are at locations where traffic density is high. The Delhi government,
one of the promoters of IGL (5% equity stake), has played a key role
in infrastructure development. It has not only provided the
necessary approvals for laying pipelines, but also extended land at
key areas on long-term leases (99 years).
Moreover, over the next 24 months, IGL plans to further strengthen
its network across Delhi, to cover all the 77 charge areas. Thus, by
2012, when IGL’s marketing exclusivity ends, its pipeline network
would cover almost all of Delhi, thereby giving it a significant
advantage over its competitors.
Diversifying operations in areas adjoining Delhi
IGL has begun its network expansion beyond NCR of Delhi to Noida,
Greater Noida, and Ghaziabad. Growth potential in these areas
remains promising, given the development of small and medium
industrial establishments, which can quickly switch over to PNG.
While industrial consumers would be the key demand drivers, CNG
and PNG would also generate healthy volume growth, given the
rapid urbanisation in these areas. By FY13, we reckon, IGL could sell
~0.8mscmd gas in these three geographies—almost 30% of its
present sales from Delhi.
Other than this, IGL has also bid in the third round for Ludhiana and
Jalandhar (both in Punjab) held by PNGRB in July 2010. We expect
companies to bid for more cities in the future, as PNGRB expects to
authorise CGD operations in 200 cities by 2015. Any new area would
present further upside to our estimates. The company has also
increased its earmarked capex plans to Rs19bn to be spent over
FY11-13 as against Rs12bn earlier.
Noida and Greater Noida: industrial consumers drive demand
growth
IGL started its operations in Noida and Greater Noida in 2009. In
these areas, IGL has established 11 CNG stations and tied up ~3,500
PNG consumers. In addition, it has a number of industrial consumers
to whom it sells ~0.06mscmd of R-LNG. Strategically, IGL is
focussing on tying up long-term contracts with these bulk
consumers. Simultaneously, the company is developing CNG and
PNG infrastructure for other classes of consumers. From 0.05mscmd
sales as of end-FY10, IGL is aiming for sales of ~0.2mscmd in FY11,
and ~0.5mscmd by FY13.
To meet its gas requirements, the government has allocated IGL
0.2mscmd APM gas, which it can sell only to its CNG and domestic
PNG consumers. To meet the needs of industrial and commercial
consumers, it has signed a contract for 0.24mscmd R-LNG with GAIL
and BPCL. Improved gas availability would also allow IGL to buy gas
from other sources, if current supply arrangements fall short of
demand.
Key risk: adverse regulatory intervention
Expansion in Ghaziabad hinges on Supreme Court decision:
Our earnings forecasts assume that IGL will continue to expand its
operations outside Delhi, thereby supporting volume growth.
However, in case the Supreme Court rules against the High Court
order, and upholds PNGRB’s power to call for bids in Ghaziabad,
Noida and Greater Noida, IGL’s earnings growth would moderate to
~12% as compared to 18% as estimated through FY11-13ii.
Any runaway increase in gas prices may lead to volatility in
quarterly margins: We reckon IGL has sufficient pricing power to
pass on increases in input costs and maintain its gross margins and
return ratios. We would like to highlight that since IGL is sourcing
incremental gas at market rates (R-LNG), where prices are mostly
linked to crude oil. Any runaway escalation in R-LNG prices,
however, would have to be passed on in a calibrated manner. This
may lead to volatility in quarterly margins, although we maintain
that margins would remain unaffected on a yearly basis. However,
should IGL fail to pass on any sharp increases in gas prices even
with a lag, a 5% fall in CNG gross spreads coupled with a 20% fall in
car conversion rate in Delhi (vis-à-vis our assumption) would
translate to an 18% drop in FY12ii earnings.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Indraprastha Gas BUY - Quality play on gas retailing
Indraprastha Gas (IGL), the sole distributor of gas in the
National Capital Region (NCR), has extensive network
penetration. This, we reckon, will enable it to maintain its
monopoly in Delhi and pass on any increase in input prices, as
reflected in the 32% increase in CNG prices since June 2010. IGL
plans to replicate its network in markets adjoining Delhi—Noida,
Greater Noida and Ghaziabad—where demand for gas remains
strong. This, we reckon, will translate into a volume CAGR of
23% and earnings CAGR of 18% over FY11-13ii. Trading at 15x
FY12ii EPS, IGL offers a quality play on gas retailing in India.
Monopoly in the high-growth Delhi market: IGL’s gas
distribution network in Delhi (2,300km of pipelines + 241 CNG
stations), is hard to replicate, and is thus unlikely to face competition
in the near future. Given that CNG is much cheaper than liquid fuels,
we expect demand to remain firm, and forecast a volume CAGR of
13% through FY11-13ii. Furthermore, launch of CNG variants by
leading car-makers (Maruti, Hyundai, etc) could increase the
monthly rate of CNG-using private vehicles from ~4,000 in 1QFY11.
This presents an upside risk to our estimate of volume growth.
Growth beyond Delhi would support further volume growth: IGL
plans to replicate its gas retailing network in Noida, Greater Noida
and Ghaziabad, where latent demand remains strong (we estimate it
at 2-3mmscmd). Such sales could grow at an exponential rate and
account for 24% of sales by FY13ii and 28% by FY15ii. Over the next
few years, the government plans to appoint CGD (city gas
distribution) operators across 200 cities through a bidding process,
which presents a further growth opportunity to IGL.
Play on emerging gas retailing business in India—BUY: Our
estimate of 18% earnings CAGR for IGL through FY11-13ii builds in
23% volume CAGR, and assumes continuance of pricing power, which
is demonstrated in the series of price hikes taken by IGL in FY11 (CNG
prices up 32% YoY). IGL’s valuation of 15x FY12ii EPS is attractive, in
our view, and is at a discount to regional peers’ multiple of 15x-20x
one-year-forward earnings. IGL offers a long-term play on the
emerging gas-retailing business in India, which we believe is set for a
massive take-off. We retain BUY with a target price of Rs400.
Investment thesis
Monopoly in the high-growth Delhi market
Thanks to the regulatory push—mandatory conversion of all public
transport vehicles to compressed natural gas (CNG) from liquid fuels,
and rapid penetration of CNG-dispensing stations across Delhi—
almost ~0.4m vehicles (private + public) currently ply on CNG.
Conversion of vehicles to CNG has also been spurred by attractive
pricing against traditional liquid fuels. For instance, per-km cost of
running a CNG vehicle is 63% and 23% lower than that of a
comparable passenger vehicle running on petrol or diesel,
respectively
(DTC) had ordered 3,500 new passenger buses to handle the
increase in traffic during the Commonwealth Games. It also plans
to phase out approximately 1,000 old buses, resulting in net
addition of 2,500 to DTC’s bus fleet and translating to an increase
of 20%. This in itself would add to CNG volumes from 2HFY11
onwards. IGL has signed a long-term contract with DTC, whereby
IGL would be the exclusive supplier of CNG to all DTC buses for
ten years.
�� Rapid increase in radio taxis: The Delhi government
introduced the first batch of “radio taxis” (call-a-cab service) in
the capital in 2006. The service has been gaining popularity
among business and leisure travellers. Since its launch in 2008,
the fleet has grown to ~3,000. This fleet is likely to be expanded
by 2,500 cabs in FY11, and by a further 2,500 in FY12, in
response to the growing popularity of these cabs. This bodes well
for CNG volumes.
�� Mandatory conversion of LCVs to CNG: The Delhi government
has mandated all LCVs registered and plying in Delhi to operate
on CNG. As of March 2010, Delhi had about 20,000 registered
LCVs, which can potentially operate on CNG. However, since the
mandate excludes carriers with national permits (which form a
large chunk of the overall population), we do not think these
conversions will result in a significant pick-up in the CNG
population, and assume ~200 conversions a year.
�� Rapid growth in PNG connections: Although IGL has a
presence in 55 of the 77 charge areas in Delhi, its network
remains under-utilised. The company currently supplies PNG to
only ~0.2m households, though it is equipped to supply to 0.6m
households. This is partly because the company has so far
concentrated on growing its CNG business, in which it enjoys
better pricing power.
However, with intensifying competition, IGL plans to improve
utilisation of its existing network by offering more connections to
domestic consumers. Over the next three years, IGL plans to
double its PNG connections from 0.2m to 0.4m.
In addition, IGL is focussing on the industrial and commercial
segment, where it expects an annual growth of 15% for the next
three years. The company has recently signed contracts to supply
gas to Hotel Leela for its new property at Chanakyapuri. In
addition, it will also supply almost 0.03mscmd gas to a 3.5MW
power plant at Thyagaraj Stadium, one of the venues of the
Commonwealth Games that were concluded in October 2010. The
plant may continue to operate after the Games thereby supplying
power to the neighbourhood.
�� Deregulation of administered petroleum products prices to
also drive volume growth: Complete deregulation of petrol
prices and partial deregulation of diesel (complete deregulation is
expected in phases) has resulted in a 22% increase in petrol
prices in Delhi. This increase in motor fuel prices has further
increased the per-km price difference between these liquid fuels
and CNG, making CNG conversion an even more economically
compelling choice.
Also, post the 12% increase in LPG prices, IGL too has increased
its PNG prices. The company has introduced differential pricing to
offset the impact of higher prices on low-gas-consuming
domestic consumers. IGL has increased prices of domestic piped
gas by ~19% (Rs18.95/scm) to consumers that consume 90scm
(equivalent to ~4 cylinders), in four months. And for consumers
that consume more than four cylinders in four months, the
applicable price increase is 23% (Rs26/scm).
��
Competition unlikely to shake IGL’s bastion in Delhi
Since its incorporation in 1998, IGL has enjoyed a monopoly.
Prospects of this monopoly continuing undisturbed came under a
cloud in 2006, when the government set up the Petroleum and
Natural Gas Regulatory Board (PNGRB) to steer development of CGD
(city gas distribution) operations across India. The primary
objectives of the board are to establish a regulatory framework,
regulate pipeline tariffs, introduce competition, and develop the
market. The board’s guidelines are applicable to PNG operations, but
CNG operations remain out of the regulatory ambit.
PNGRB has allowed a period of exclusivity for the companies that
were functional prior to its incorporation. Once the exclusivity period
ends, these areas would be open to competition.
The board has given IGL marketing exclusivity in PNG till January
2012, and network exclusivity till 2025. Thus, IGL will remain the
sole distributor of PNG in Delhi till 2012. Thereafter, other players
will be able to market PNG using IGL’s infrastructure, for which IGL
would receive a fixed charge (network exclusivity). The new entrants
will be allowed to develop their network only in areas where IGL
does not have its infrastructure in place.
In our view, IGL’s operations would remain unaffected by such
competition, as: 1) it has established a wide network in Delhi that is
hard to replicate; 2) it has set up this network at costs that are
substantially below the current setup costs; and 3) stringent
regulations that disallow duplication of the network will significantly
reduce operational flexibility for any new entrant.
IGL’s network reaches almost 75% of Delhi
Over the past ten years of its operations, IGL has built a pipeline
network spanning 2,300km across Delhi. The network covers 55 of
the 77 charge areas (as defined in the Delhi Master Plan). With an
aggregate compression capacity of 2.91m kg/day, IGL has the
second-largest CGD network in India. In addition to its widespread
network, IGL has the highest number of CNG dispensing stations in
India (241 as of FY10).
PNG retailing requires widespread penetration of the pipeline, while
the CNG business demands presence in key city locations. IGL has a
widespread pipeline network, and its 241 CNG stations across Delhi
are at locations where traffic density is high. The Delhi government,
one of the promoters of IGL (5% equity stake), has played a key role
in infrastructure development. It has not only provided the
necessary approvals for laying pipelines, but also extended land at
key areas on long-term leases (99 years).
Moreover, over the next 24 months, IGL plans to further strengthen
its network across Delhi, to cover all the 77 charge areas. Thus, by
2012, when IGL’s marketing exclusivity ends, its pipeline network
would cover almost all of Delhi, thereby giving it a significant
advantage over its competitors.
Diversifying operations in areas adjoining Delhi
IGL has begun its network expansion beyond NCR of Delhi to Noida,
Greater Noida, and Ghaziabad. Growth potential in these areas
remains promising, given the development of small and medium
industrial establishments, which can quickly switch over to PNG.
While industrial consumers would be the key demand drivers, CNG
and PNG would also generate healthy volume growth, given the
rapid urbanisation in these areas. By FY13, we reckon, IGL could sell
~0.8mscmd gas in these three geographies—almost 30% of its
present sales from Delhi.
Other than this, IGL has also bid in the third round for Ludhiana and
Jalandhar (both in Punjab) held by PNGRB in July 2010. We expect
companies to bid for more cities in the future, as PNGRB expects to
authorise CGD operations in 200 cities by 2015. Any new area would
present further upside to our estimates. The company has also
increased its earmarked capex plans to Rs19bn to be spent over
FY11-13 as against Rs12bn earlier.
Noida and Greater Noida: industrial consumers drive demand
growth
IGL started its operations in Noida and Greater Noida in 2009. In
these areas, IGL has established 11 CNG stations and tied up ~3,500
PNG consumers. In addition, it has a number of industrial consumers
to whom it sells ~0.06mscmd of R-LNG. Strategically, IGL is
focussing on tying up long-term contracts with these bulk
consumers. Simultaneously, the company is developing CNG and
PNG infrastructure for other classes of consumers. From 0.05mscmd
sales as of end-FY10, IGL is aiming for sales of ~0.2mscmd in FY11,
and ~0.5mscmd by FY13.
To meet its gas requirements, the government has allocated IGL
0.2mscmd APM gas, which it can sell only to its CNG and domestic
PNG consumers. To meet the needs of industrial and commercial
consumers, it has signed a contract for 0.24mscmd R-LNG with GAIL
and BPCL. Improved gas availability would also allow IGL to buy gas
from other sources, if current supply arrangements fall short of
demand.
Key risk: adverse regulatory intervention
Expansion in Ghaziabad hinges on Supreme Court decision:
Our earnings forecasts assume that IGL will continue to expand its
operations outside Delhi, thereby supporting volume growth.
However, in case the Supreme Court rules against the High Court
order, and upholds PNGRB’s power to call for bids in Ghaziabad,
Noida and Greater Noida, IGL’s earnings growth would moderate to
~12% as compared to 18% as estimated through FY11-13ii.
Any runaway increase in gas prices may lead to volatility in
quarterly margins: We reckon IGL has sufficient pricing power to
pass on increases in input costs and maintain its gross margins and
return ratios. We would like to highlight that since IGL is sourcing
incremental gas at market rates (R-LNG), where prices are mostly
linked to crude oil. Any runaway escalation in R-LNG prices,
however, would have to be passed on in a calibrated manner. This
may lead to volatility in quarterly margins, although we maintain
that margins would remain unaffected on a yearly basis. However,
should IGL fail to pass on any sharp increases in gas prices even
with a lag, a 5% fall in CNG gross spreads coupled with a 20% fall in
car conversion rate in Delhi (vis-à-vis our assumption) would
translate to an 18% drop in FY12ii earnings.
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