We evaluate the impact of COVID 19 on CGD sector and trends in domestic gas costs, LNG and crude. COVID 19 can hurt CNG and industrial PNG volumes in the near term prompting us to lower our FY21e/22e volumes by 18-25%/8-12%, which results in 22-33%/9-13% cut in FY21e/22e EPS. But the sector is helped by lower domestic costs and softer LNG prices amid flattish petrol/diesel prices despite lower crude. We prefer GUJGA (Buy) and MGL (Buy) over IGL (Hold).
CNG: With commuting sharply impacted, we estimate CNG volumes (~ 75% of MGL/IGL volumes, ~ 15% of GUJGA volumes) to be ~ 90% lower than normal during lockdown in Mumbai and Delhi. This could lead to ~50% y-o-y decline in overall volumes in Q1FY21e for MGL/IGL.
Domestic PNG: Domestic PNG (~ 10% of volumes) could however be much more resilient but customer additions would be challenging till the situation normalises.
Industrial PNG: Industrial PNG (~ 80% of GUJGA volumes, ~ 15% of MGL/IGL volumes) though could suffer materially. Eg: Morbi units are currently not operational but we expect them to restart operations in the next ten days.
Revisions: This prompts us to cut our volume estimates for CGD in FY21e/22e by 18-25%/8-12% respectively. With limited operating leverage, the downward revision in Ebitda stands at 17-26% for FY21e. The resulting FY21e/22e EPS cut is 22-23/9-11% for MGL/IGL (debt free) and 33/13% for GUJGA.
Balance Sheet: We expect the companies to be FCF positive in FY21e despite the disruption. Even otherwise, MGL and IGL are net cash while the balance sheet of GUJGA looks robust too at a modest 1.5x net debt/Ebitda amid positive FCF.
Domestic gas reset: Domestic APM gas price was lowered by ~ 25% for 1HFY21e to $2.7/mmbtu NCV and we expect it to reduce further to near $2/mmbtu over the next year. With domestic gas being the feedstock for CNG and domestic PNG (~ 85% of volumes for MGL/IGL and ~ 20% of volumes for GUJGA) MGL’s price cut of Rs 2/kg could provide scope for near term margin expansion while IGL took a price cut of Rs 3.2/kg in line with margin neutral cut at 76 INR.
LNG/crude: Lower crude has hardly translated to lower petrol/diesel prices (down ~ Rs1.5/l since Mar) leaving CNG at ~40-55% discount to diesel/petrol. Impact of lower liquid industrial fuel price for GUJGA can be mitigated by lower LNG costs (can be passed through), limited competition in Morbi and regulatory push against dirty fuels in other areas too.
Recommendation: CGD sector has outperformed the broader market (IGL up 10%, GUJGA flat, MGL down 10%) in 2020 (Nifty down 23%). We have kept our target multiples unchanged at 16x for MGL and 20x for GUJGA and IGL but lower FY22e EPS results in a PT of Rs 1,290 for MGL (from Rs 1,410), Rs 320 for GUJGA (from Rs 360) and Rs 430 for IGL (from Rs 470). Indeed, rich valuations at 22x FY22e P/E keeps us on the sidelines for IGL while we continue to prefer GUJGA (policy support, lower regulatory risk and less mature area profile) and MGL (margin expansion catalyst, solid balance sheet/FCF and modest valuation).