Mahanagar Gas Ltd BUY. Pioneer of City Gas Distribution in Mumbai

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1 Utilities - Utility Networks Bloomberg Code: MAHGL IN India Research - Stock Broking Pioneer of City Gas Distribution in Mumbai Sole authorised distributor of CNG and PNG in Mumbai and adjoining areas: MGL is one of the largest players in City Gas Distribution (CGD) and is the only distributor of CNG and PNG in Mumbai and its adjoining areas. The company has infrastructure exclusivity i.e. exclusive authorisation to lay, build, expand and operate the CGD network in Mumbai till 2020, adjoining areas till 2030 and Raigad district until Falling natural gas prices to improve margins and increase demand: The natural gas prices in India have declined over the past 1 and half year. The decline in prices is mainly led by decline in prices in the reference countries like US, UK, Russia and Canada. Going forward, the prices are further expected to decline from current levels of US$ 3.06 per MMBTU. Also surplus availability in the reference countries like US is likely to keep prices subdued. Mahanagar gas is likely to benefit from the falling natural gas prices, as this will help the company to reduce its natural gas cost and improve margins going forward. Falling prices will also lead to higher demand for CNG. Large untapped potential in existing areas of operations: The current penetration levels in CNG and PNG domestic segment are about ~30%. Hence, there is huge untapped potential in both the segments which will help the company to register high sales growth going forward. Valuation and Outlook Mahanagar gas is one of the largest players in the CGD industry with operations in Mumbai and adjoining areas. The company has zero debt, healthy margins and return ratios. At CMP of Rs. 608, it is trading at 12.7x FY18E EPS. We value the company at 16.0x FY18E EPS and initiate coverage on the company with BUY rating, for a price target of Rs. 766, representing an upside of 26% for a period of 9-12 months. Key Risks yadverse movement in domestic natural gas prices / R-LNG prices / crude oil prices. yunfavourable regulations from MoPNG and PNGRB. yuncertainity over marketing exclusivity by PNGRB. ydelays in expansion and completion of expansion plans. Exhibit 1: Valuation Summary YE Mar (Rs. Mn) FY14 FY15 FY16 FY17E FY18E Net Sales EBITDA EBITDA Margin (%) Net Profit EPS (Rs.) RoE (%) PE (x) For private circulation only. For important information about Karvy s rating system and other disclosures refer to the end of this material. Karvy Stock Broking Research is also available on Bloomberg, KRVY<GO>, Thomson Publishers & Reuters Recommendation (Rs.) Sep 20, 2016 BUY CMP (as on Sep 19, 2016) 608 Target Price 766 Upside (%) 26 Stock Information Mkt Cap (Rs.mn/US$ mn) / wk High/Low (Rs.) 653 / 487 Avg. daily volume (mn)* 0.2 Sensex/Nifty / 8808 O/S Shares(mn) 99.0 Face Value (Rs.) 10.0 * Since listing Shareholding Pattern (%) Promoters 65.0 FIIs 10.7 DIIs 1.7 Others 22.6 Stock Performance (%) 1M Since Listing Absolute Relative to Sensex Source: Bloomberg Relative Performance* Jun-16 Jul-16 Jul-16 Jul-16 Source: Bloomberg; *Index 100 Analyst Contact Radhika Pranjal Goyal Jul-16 Aug-16 Aug-16 radhika.goyal@karvy.com Aug-16 Aug-16 Sep-16 Sep-16 Sensex Sep-16 1

2 Company Financial Snapshot (Y/E Mar) Profit & Loss (Rs. Mn) FY16 FY17E FY18E Net sales Optg. Exp EBITDA Other Income & Exceptional Items Depreciation Interest PBT Tax Adj. PAT Profit & Loss Ratios EBITDA margin (%) Net margin (%) P/E (x) EV/EBITDA (x) Dividend Yield (%) Balance sheet (Rs. Mn) FY16 FY17E FY18E Total Assets Net Fixed assets Current assets Other assets Total Liabilities Networth Long Term & Short Term Debt Current Liabilities Other Liabilities Balance Sheet Ratios RoE (%) RoCE (%) Debt/Equity Equity/Total Assets P/BV (x) Exhibit 2: Shareholding Pattern (%) Company Background (MGL) is one of the largest CGD compaines in India. Started in 1995, the company has more than 20 years of experience in supplying natural gas in Mumbai. The company is sole authorised distributor of Compressed Natural Gas (CNG) and Piped Natural Gas (PNG) in Mumbai, its adjoining areas and Raigad district in Maharashtra. The promoters of the company are GAIL (32.5%) and BGAPH (BG Asia Pacific Holdings Pte. Ltd) (32.5%).; part of Shell group. The company provides CNG to 0.47 mn vehicles through its network of 188 CNG filling stations, supplies PNG to 0.86 mn domestic households, 2,866 commercial and 60 industrial consumers in Mumbai and its adjoining areas. The company distributes natural gas through an extensive CGD network of pipelines. As on Mar 31, 2016, the company has supply network of 4,646 kms of pipeline. The company has infrastructure exclusivity i.e. exclusive authorisation to lay, build, expand and operate the CGD network in Mumbai till 2020, adjoining areas till 2030 and Raigad district until Cash Flow (Rs. Mn) Exhibit 3: Revenue Segmentation - FY16 (%) FY16 FY17E FY18E PBT Depreciation Interest Tax (1501) (1939) (2349) Changes in WC Others (273) (492) (610) CF from Operations Capex (2210) (2271) (2021) Investments & Others (76) 492 (1090) CF from Investing (2286) (1779) (3111) Change in Debt (18) 66 (15) Interest (15) (25) (35) Dividends & Other (1882) (2081) (2081) CF from Financing (1914) (2040) (2131) Change in Cash FIIs 1.7% Others 22.6% PNG 28.8% DIIs 10.7% Promoters 65.0% CNG 70.6% Others 0.7% Source: BSE, Karvy Research 2

3 Natural Gas Industry in India Sedimentary basins: India has 26 sedimentary basins covering an area of 3.14 Mn sq kms. Sedimentary basins are nothing but regions of earth of long term subsidence creating accommodation space for infilling by sediments (accumulation of sand and dirt). Broadly, they have been divided into four categories based on their degree of prospects as presently known. Of the 4 categories, category 1 consists of 7 basins where commercial production of natural gas has been established. These basins are Cambay, Assam shelf, Mumbai Offshore, Krishna Godavari, Cauvery, Assam Arakan Fold belt and Rajasthan. Source: Industry; Karvy Research 3

4 Exhibit 4: Natural gas reserves Natural gas reserves (bcm) Proven reserves Conventional onshore 290 Shallow offshore 340 Deep offshore 770 Coalbed Methane 20 Shale gas 0 Total India 1,420 Source: International Energy Agency (IEA), world energy outlook 2015, Karvy Research Demand Supply Scenario As per IEA world energy outlook report 2015, as on 2014 India has 1,420 bcm (billion cubic meter) of proven natural gas reserves. Exhibit 5: Demand supply scenario FY10 FY11 FY12 FY13 Production (bcm) FY14 FY15 FY16P Consumption (bcm) FY17P (Apr-Jun) Against this, the total natural gas production in FY16 was 32.25bcm. ONGC is the largest producer of natural gas. Of the total production, it contributed bcm (66%) followed by Oil India Ltd (OIL) 2.84 bcm (9%). JVs/Pvt contributed rest of 26%. Of the total production, 71% came from Offshore and 29% from Onshore. The production has been declining from FY12 as the existing gas fields have matured and production from these fields is on a natural decline. The increasing demand for natural gas has been met by imports of Liquefied Natural Gas (LNG). Source: Ministry of Petroleum & Natural gas, Petroleum Planning & Analysis Cell, Karvy Research Note: FY12 onwards consumption no.s include R-LNG imports, FY16 no.s and April-June 2016 are provisional no.s Exhibit 6: YoY trend in LNG imports Source: Ministry of Petroleum & Natural gas; Karvy Research Note: FY16 no.s are provisional 15.5 Exhibit 7: Sector-wise natural gas consumption (%) 21.3 FY12 FY13 FY14 FY15 FY16P LNG Imports (MMT) Going forward, the additional demand for gas is likely to be met through LNG imports. LNG is converted into natural gas through re-gasification process at R-LNG plants and then transported through pipes to end consumers. The RLNG terminals are located at Dahej (Gujarat), Hazira (Gujarat), Kochi (Cochin) and Dhabol (Maharashtra). The companies having RLNG terminals include Petronet LNG Ltd, GAIL (India) Ltd, Gujarat State Petroleum Corporation Ltd (GSPCL), Reliance Industries, Hazira LNG and Indian Oil Corporation Ltd (IOCL). The current capacity of RLNG terminal in India is 21.7 MMT per annum. The LNG imports have been increasing since past few years. In FY16, LNG imports grew by 38% YoY. With the increasing demand for LNG, the capacity of R-LNG terminals is expected to increase manifold. Petrochemical 6.2% Refinery 9.8% Others 17.1% Fertilizer 32.5% Fertilizer and Power sectors are the biggest contributors to natural gas demand in India. Going forward, significant demand for natural gas is also expected to come from industrial and CGD sectors. CGD 11.6% Power 22.9% Source: PNGRB report Vision 2030, Karvy Research 4

5 Outlook Exhibit 8: Increasing gap between demand and supply (bcm) Natural Gas Production Natural Gas Consumption Gap Source: International Energy Agency (IEA), world energy outlook 2015; Karvy Research According to IEA, India s natural gas production is expected to increase to 38bcm in 2020 and will go upto 55bcm in 2030 and 89bcm in During the same time, the demand for natural gas is expected to increase at a higher rate to reach 180bcm in 2040 leaving a gap of 90bcm. This difference in demand and supply is expected to be met mostly through LNG imports (90%) and rest through proposed natural gas pipelines (10%). Natural gas chain in India Natural gas sector is divided into various segments. Given below is the natural gas chain in India. Liquefied Natural Gas (LNG) is imported to meet the growing demand of natural gas in India FY16 - total imports MMT LNG is converted into natural gas at LNG terminals through regasification process and transported to consumers through pipes R-LNG Terminals Location Player Capacity (MMTPA) 1. Dahej, Gujarat Petronet LNG Hazira, Gujarat Hazira LNG 5 3. Kochi, Cochin Petronet LNG 5 4. Dhabol, Maharashtra GAIL 1.7 LNG Imports R-LNG (Regassified Liquid Natural Gas) Terminals Transmission Pipelines City Gate Stations City Gas Distribution (CGD) End Consumer Natural Gas Production Proven Natural gas reserves of 1,420bcm Players-ONGC, OIL and Pvt/JVs. ONGC has the largest share (66%) Majority production coming from Offshore-> 70% FY16 Production -32.3bcm Current gas pipeline network in India is 17,421 Kms. GAIL is the largest player in this segment with share of 63%. Other players in this segment are Gujarat State Petronet Ltd, Reliance Industries. Regional imbalance-gujarat, Maharashtra and UP together consume more that 65% of the available gas. As per PNGRB report vission 2030, India is expected to have a pipeline infrastructure of 32,727 kms. ~70 cities covered under CGD network Comprises of LNG and PNG (Priority sector), Industrial and Commercial PNG There are total 1,081 CNG stations and 3.2 mn PNG connections and ~2.56 mn, CNG vehicles across India (Data as on April 2016). Largest Players in the segment include - Indraprastha Gas Ltd, and Gujarat Gas Ltd Source: Ministry of petroleum and natural gas, Petroleum Planning & Analysis Cell (PPAC), PNGRB report vision 2030, Karvy Research City Gas Distribution (CGD) CGD is an important segment for distribution of CNG and PNG in cities across India. The Indian CGD market size was estimated at Rs. 240 bn in fiscal 2014 with sales volume of 20 MMSCMD (Mn Metric Standard Cubic Meter per Day). The GoI has given Petroleum and Natural Gas Regulatory board (PNGRB) the mandate to set up CGD network in cities across the country. There are 20 CGD players operating/developing CGD networks in ~70 cities in the country. The 3 major players in the industry include Indraprastha Gas Ltd (IGL), (MGL) and Gujarat Gas Ltd (GGL) accounting for 60% of the total sales volume. The region-wise distribution of PNG connections in India is skewed mainly towards 3 geographical areas viz; Gujarat, Maharashtra and Delhi with 3 of them together comprising of 95% of total connections. Majority of CNG stations are also found mainly in the above mentioned locations with UP and AP having a share of 4.2% and 3.1% respectively. 5

6 Exhibit 9: Region-wise PNG distribution (%) Gujarat 47.5% Maharashtra 28.3% Delhi / NCR 20.3% Others 4.0% Sep 20, 2016 Exhibit 10: Region-wise distribution of CNG stations in India (%) Gujarat 34.9% Maharashtra 20.8% Delhi / NCR 31.5% UP 4.2% AP 3.1% Others 5.5% Source: Petroleum Planning & Analysis Cell (PPAC), Karvy Research Source: PPAC, Karvy Research Given below is statewise no. of CNG stations, CNG vehicles and PNG connections in India Exhibit 11: CGD Statistics State Players No. of CNG Stations No. of CNG Vehicles PNG connections Delhi / NCR Indraprastha Gas Ltd. (IGL), New Delhi 340 8,23,298 6,48,771 Gujarat Maharashtra Adani Energy Ltd., Gujarat Gas Ltd., Sabarmati Gas Ltd., Hindustan Petroleum Corporation Ltd., Vadodara Gas Limited.(MGL),Mumbai, Maharashtra Natural Gas Ltd., (MNGL), Pune, GAIL Gas Ltd ,64,735 15,20, ,67,785 9,04,597 Andhra Pradesh / Telangana Bhagyanagar Gas Ltd. (BGL), Hyderabad ,270 4,360 Rajasthan Gail Gas Ltd. 3 4, Uttar Pradesh Green Gas Ltd. (Lucknow), Central UP Gas Ltd. (Kanpur), Siti Energy Ltd., Adani Energy Ltd., GAIL Gas Ltd., Sanwaria Gas Ltd. 45 1,05,238 35,369 Tripura Tripura Natural Gas Co. Ltd., Agartala. 5 8,063 23,434 Madhya Pradesh Avantika Gas Ltd. (Indore), GAIL Gas Ltd ,139 6,729 Haryana Haryana City Gas Ltd, GAIL Gas Ltd., Adani Gas Ltd. 24 1,23,372 31,840 West Bengal Great Eastern Energy Corporation Ltd. 7 2,275 - Assam Assam Gas Co Ltd ,172 All India 1,081 25,57,895 32,04,642 Source: PPAC, Karvy Research, Note: Data as on April 01, 2016 Government efforts to promote CGD sector: In recent past, the government of India has taken various steps to promote CGD industry. For instance, in February 2014, MoPNG issued guidelines to meet 100% requirements of natural gas of CGD priority sector (CNG and domestic PNG) before which the CGD companies were meeting additional demand through imports. In October 2014, MoPNG came out with revised guidelines and directed GAIL to allocate additional 10% to meet incremental demand of the CGD companies. These steps taken by government ensure that it is taking serious efforts to promote CGD sector. Increased allocation of domestic natural gas to CGD companies will reduce their dependence on expensive R-LNG imports thus resulting lower input cost and will also benefit end consumers as the gas supplied to them will be of low cost. Sourcing of natural gas: Sourcing of cheap natural gas is a very crucial when one looks at the business model of CGD companies. In India, the domestically produced natural gas is categorised under four different categories- 1) Administered Price Mechanism (APM) gas 2) Non-APM gas 3) Pre-New Exploration Licensing Policy (NELP) 4) NELP. Gas produced under each category is allocated under different gas utilisation policies. Although the policy for allocation under each category has similar priority, there are many ambiguities and anomalies. In order to overcome these anomalies and correct imperfections in the existing policies, the current government is proposing a new policy called Unified Allocation Policy (UAP). Under the new policy, under order of priority, the CGD companies are moved to the top in the list. With this change in the priority list, we believe that the CGD companies are expected to benefit. 6

7 Exhibit 12: Natural Gas Allocation Policies Current Policy for NELP regime Order of priority Gas based urea plants Gas based LPG plants Gas based power plants with existing PPAs CGD (CNG & domestic) Others (Steel, refineries, CGD (industrial & commercial)) Existing plants are prioritised over new plants Source: Final Offer document of, Karvy Research Proposed Policy (UAP) for All regimes Order of priority CGD (CNG & domestic) Plants that provide inputs to strategic sectors of atomic energy & space research Gas based LPG & petrochemical plants Gas bases urea plants Gas based power plants with existing PPAs Others Domestic Gas Pricing: In Oct 2014, the Government of India came out with new gas pricing formula for domestically produced natural gas. According to the new formula, the domestic gas sale prices to be the weighted average of gas prices in US, Canada, UK and Russia. The gas prices are determined on a half yearly basis (Apr-Sept and Oct-March). Since the announcement of formula, the gas prices in the reference countries have declined and accordingly the gas prices in India have followed the trend. As per the said formula, the gas prices in India have declined from US$ 5.05 MMBTU in H2FY15 to US$ 3.06 MMBTU in H1FY17. Further, the gas prices are expected to come down in H2FY17E. Outlook on the sector: The PNGRB has envisaged a rollout plan for CGD network through competitive bidding in more than 300 Geographical Areas (GAs) in a phased manner. In its sixth round of bidding in Oct 2015, PNGRB has bid out 34 GAs to set up CGD network. The bids were invited for the development of 9 states viz; Madhya Pradesh(5), Gujarat(8), Maharashtra (2), Uttar Pradesh(8), Karnataka (2), Haryana (4), Goa (1), Punjab (3) and Uttarakhand (1). Further, PNGRB has identified 106 GAs for subsequent bidding rounds subject to natural gas pipeline connectivity. The growth of CGD industry has been slow mainly due to lack of infrastructure availability. 7

8 Company Overview FY98 1st natural gas supply & transportation contract signed with GAIL. FY09 Completed laying 2,000 km of PE pipeline. FY11 Completed laying 200km of steel pipeline Achieved domestic customer base of 0.5mn. FY13 Completed more than 350 km of steel pipeline. Achieved a customer base of 1mn. (MGL) is one of the largest City Gas Distribution (CGD) companies in India. Started in 1995, the company has more than 20 years of experience in supplying natural gas in Mumbai. The company is sole authorised distributor of CNG and PNG in Mumbai, its adjoining areas and Raigad district in Maharashtra. The promoters of the company are GAIL (32.5%) and BGAPH (BG Asia Pacific Holdings Pte. Ltd) (32.5%).; part of Shell group. The company provides CNG to 0.47 mn vehicles through its network of 188 CNG filling stations and supplies PNG to 0.86 mn domestic households, 2,866 commercial and 60 industrial consumers in Mumbai and its adjoining areas. The company distributes natural gas through an extensive CGD network of pipelines. As on Mar 31, 2016, the company has supply network of 4,646 kms of pipeline. The company has infrastructure exclusivity i.e. exclusive authorisation to lay, build, expand and operate the CGD network in Mumbai till 2020, adjoining areas till 2030 and Raigad district until In 2015, the company was awarded the license for the Raigad district in the 4th round of CGD bidding. Source: Final Offer Document of MGL, Karvy Research Business Profile The company derives its sales from selling natural gas in the form of CNG to vehicles and PNG to domestic, industrial and commercial customers. As on FY16, the total natural gas sold by the company was 2.43 MMSCMD. Of this, 74.1% was CNG followed by PNG which was 25.9%. Of this, PNG supply to domestic household contributed 11.5%, commercial contributed 6.2% and industrial 8.2%. Domestically sourced natural gas can be sold only to CNG and PNG domestic which are the priority sectors. To supply gas to industrial and commercial customers, the company procures imported R-LNG. During FY16, sales to priority sector (CNG and domestic PNG) was 85.6% of total sales. Natural gas volume sales have grown at a CAGR of 5.5% from FY12-FY16. Exhibit 13: Sales volume mix (In MMSCMD) Exhibit 14: Sales volume breakup (%) PNG- Domestic 11.5% PNG- Commercial 6.2% CNG 74.1% PNG- Industrial 8.2% 0.0 FY12 FY13 FY14 FY15 FY16 CNG PNG Source: Final Offer Document, Karvy Research Source: Final Offer Document, Karvy Research As on Mar 31, 2016 the company has 188 CNG stations. Most of these stations are online stations. Online stations are ones which are connected to natural gas pipeline for dispensation of CNG to vehicles but do not have mobile cascade filling facility i.e. CNG cannot be transported from online stations to other CNG stations. Of the total no. of stations, 13 are owned by the company and rest are owned by BPCL, HPCL and IOCL. 8

9 Exhibit 15: CNG Stations Sep 20, 2016 Type of CNG filling stations (As on FY16) Number of Stations Owned by the Company 13 Owned by: Bharat Petroleum Corporation Limited (BPCL) 53 Hindustan Petroleum Corporation Limited (HPCL) 54 Indian Oil Corporation Limited (IOCL) 29 Owned by other private and other parties 39 Total 188 Source: Final Offer document, Karvy Research Exhibit 16: Domestic connections Source: Final Offer Document, Karvy Research FY12 FY13 FY14 FY15 FY16 Domestic connections The total no. of domestic PNG connections of the company increased from 0.56 mn in FY12 to 0.86 mn in FY16; recording a CAGR of 11.4%. During the same period, the commercial connections increased from 1,502 to 2,866 and industrial connections increased from 38 to 60. The growth in industrial and commercial segments have been limited due to competition from alternate fuels. Infrastructure The company owns 4 City Gate Stations (CGSs) located at Wadala, Mahape, Ambernath and Taloja. Most of the natural gas is received at Wadala station. The gas at these stations is supplied by the pipelines owned by GAIL. The gas from these stations is distributed through the company s own pipeline network to its CNG stations and PNG consumers. Given below is the flow of natural gas from CGSs to end consumers. City Gate Stations (4) District Regulator Station CNG Stations (188) Major industrial consumer Service Regulator Meter Regulator PNG Consumer Source: Final Offer document of ; Karvy Research The district regulator station is where the pressure of natural gas is reduced and regulated. Further, any impurity such as dust is filtered. Service regulator and meter regulator stations are installed at the consumers end. They further regulate the pressure of natural gas to be distributed through smaller diameter Polyethylene (PE) pipelines to end consumers. 9

10 GAIL-The sole supplier of natural gas: The company sources majority of its natural gas requirement from GAIL. The company has entered into various agreements with GAIL for supply of natural gas. Under Domestic Natural Gas Agreement, the total contracted quantity stands at 1.67MMSCMD with maximum permissible availability of 1.84MMSCMD. Gas procured under Domestic Sale Agreement is also known as APM (Administered Price Mechanism) gas. Under PMT (Panna Mukta and Tapti fields) Agreement with GAIL, the total contracted quantity stands at 0.5MMSCMD with maximum permissible availability of 0.55MMSCMD. Gas sourced under above mentioned two agreements to be sold to the priority sector (CNG and domestic PNG) only. Under Gas Sale Agreement, total Exhibit 17: Natural gas mix (MMSCMD) PMT 0.52 APM 1.6 Source: Final Offer Document, Karvy Research Non apm 0.07 Term RLNG 0.15 SPOT 0.14 contracted quantity stands at 0.15 MMSCMD on firm basis and 0.15MMSCMD on fallback basis. Under firm basis, GAIL is obligated to sell the contracted quantity. However, under fallback basis, GAIL will supply only if it has additional gas after meeting the requirements of other companies. The company also enters into spot RLNG contracts with various suppliers like GAIL, HPCL, BPCL, Hazira LNG among others for additional supply of gas. The company procures 94% of the total natural gas requirement through long term and mid-term contracts with GAIL. Only 6% of the remaining requirement is procured through spot contracts with R-LNG suppliers. Exhibit 18: Details of Gas Agreements Company GAIL Gas Sourcing Agreement Domestic Natural Gas Agreement (APM) Contracted Quantity (MMSCMD) Maximum Permissible Availability (MMSCMD) Expiry Sale to Mar-21 Priority Sector GAIL PMT Agreement NA Priority Sector GAIL Gas Sale Agreement 0.15 on firm basis, 0.15 on fallback basis Dec-16 Non-priority like commercial, industrial Source: Final Offer document, Karvy Research Pricing: Current prices of APM gas are US$ 3.06 per MMBTU. This price is applicable till Sept 2016 and the revised price will be applicable from Oct The government revises the price of natural gas every six months. (April-Sept and Oct-March). The current price applicable to the company under Panna-Mukta field is US$ 5.73 per MMBTU and under Tapti field is US$ 5.57 per MMBTU which is higher as compared to APM. However, 65% of the total gas procured by the company is from APM i.e. low cost gas. This helps the company in keeping its raw material cost low and report better margins. The price at which the company sells gas to its customers is not regulated. The company has the freedom to pass on any increase in natural gas prices to its customers. This helps the company to maintain its gross margins. Business Strategy going forward: The company plans to increase its penetration in Mumbai and its adjoining areas by reaching out to new customers for CNG, domestic PNG, commercial PNG and industrial PNG use. The company plans to add 83 CNG filling stations and add over 675 kms of pipeline in its existing area of operations over the next 5 years. Most of these CNG stations will be owned by the company. For FY17E, the company has earmarked a capex of Rs. 2,500 mn. All this capex will be funded through internal accruals. For long term growth, the company also plans to enter into new markets by participating in the bidding process for CGD companies announced by PNGRB from time to time and it is also open to explore opportunities in new GAs through value accretive acquisition of companies. 10

11 Investment Rationale Sep 20, 2016 Sole authorised distributor of CNG and PNG in Mumbai and adjoining areas: MGL is one of the largest players in CGD and the only distributor of CNG and PNG in Mumbai and its adjoining areas. The company has infrastructure exclusivity ie exclusive authorisation to lay, build, expand and operate the CGD network in Mumbai till 2020, adjoining areas till 2030 and Raigad district until Falling natural gas prices to improve margins: The natural gas prices in India have declined over the past 1 and half year. The decline in prices is mainly led by decline in prices in the reference countries like US, UK, Russia and Canada. Going forward, the prices are further expected to decline to US$ 2.5 per MMBTU from current levels of US$3.06 per MMBTU. Also surplus availability in the reference countries like US is likely to keep prices subdued. Mahanagar gas is likely to benefit from the falling natural gas prices as this will help the company to reduce its natural gas cost and improve margins going forward. CNG potential in Mumbai and its adjoining areas: The company currently operates in Mumbai and its adjoining areas. (Thane city, Mira road, Bhayender, Navi Mumbai, Ambernath, Bhiwandi, Kalyan, Dombivali, Badlapur, Ulhasnagar, Panvel, Khargar and Taloja). However, majority of CNG stations of the company are in Mumbai. According to the management, the addressable potential market for CNG vehicles is of around 1.8 mn. As on Mar 31, 2016, 0.47 mn vehicles were running on CNG resulting into penetration level of 26%. Hence, there is a large untapped potential for the company to further increase its penetration level and increase its CNG sales going forward. The company plans to convert 0.06 mn vehicles into CNG every year. In order to penetrate further and increase its CNG sales, the company plans to set up CNG stations in FY17E and another 20 stations in FY18E. Automobile manufacturing companies supporting the use of CNG: Many automobile manufacturing companies are coming up with dual fuel vehicles (CNG+Petrol) thus supporting the consumption of CNG. However, this trend is mainly visible in metros like Delhi and Mumbai. For instance, Maruti Suzuki has taken the lead in CNG and has installed a separate manufacturing line for its CNG car models at its Manesar plant. The company offers 6 models with CNG variant. These include Alto 800, Alto K10, Celerio, Wagon R, EEco and Ertiga. Other car manufacturing companies who offer CNG variants include Tata motors and Hyundai. Exhibit 19: CNG Car Variants in India Maruti Suzuki Hyundai Tata Motors Maruti Suzuki 800 CNG Hyundai Grand i10 CNG Tata Nano emax Maruti Suzuki Celerio CNG Hyundai Xcent CNG Maruti Suzuki Wagon R CNG Maruti Suzuki Alto K10 CNG Maruti Suzuki Ertiga CNG Source: Industry, Karvy Research CNG enjoys cost advantage over alternate fuels: CNG directly competes with alternative fuels like petrol and diesel in the vehicle segment. The CNG is preferred over petrol because of high fuel efficiency as it gives more mileage and lower running cost. However, when compared on the basis of upfront cost, CNG is more expensive as compared to petrol but cheaper than diesel. However, the conversion of vehicles to CNG is restricted to only Metros. This is mainly because of unavailability of infrastructure in other cities. With the company planning more CNG stations in FY17E and FY18E, the availability of CNG stations will increase thus resulting into higher demand for CNG. PNG penetration to increase: As per management guidance, there are 0.3 mn potential households in current areas of operations which include Greater Mumbai and Thane city. The company has total domestic PNG connections of 0.86mn as on Mar 31, Hence, the total penetration level in existing areas of operations is only 29%. Going forward the company plans to increase its penetration in the Greater Mumbai and Thane city area and slowly expand to other less penetrated areas of Thane district like Kalyan, Dombivali, Ambernath and Badlapur. The company has been adding on an average 75,000 new PNG connections every year. However going forward, the management expects to add 1 mn to 1.25 mn new PNG domestic connections on yearly basis. The increase in run rate is mainly due to adoption of new policy wherein the company expects to lay smaller length pipes between main road and society in the lean season which will help the company in ramping up the laying of pipeline infrastructure resulting into more connections per year. 11

12 Comfort and convenience in using LPG: Sep 20, 2016 Comfort factors related to PNG include no ordering and changing of cylinders; and no requirement of storage space. Convenience factors include related to bill payment like bi-monthly billing, transparency, online bill payment facility and customers can view past bills among others. In metropolitan cities, where majority of population is working, usage of PNG is definitely more convenient and hassle free. Going forward, along with economic advantage, above mentioned factors will also contribute to increased demand for PNG. Removal of LPG subsidy by government: Domestic PNG competes directly with subsidised LPG. In December 2015, the government announced removal of LPG subsidy for households where registered consumer or his/her partner have annual income of more than Rs. 1 mn. This will also push consumers to switch from LPG to PNG. Government s mission to have 10mn PNG connections by 2020: The government of India wants city gas distributors to increase the piped gas across the country. It has set a target of 10 mn PNG connections by 2020 as against current number of 3.2mn as on April

13 Exhibit 20: Business Assumptions Y/E Mar (Rs. Mn) FY15 FY16 FY17E FY18E Comments Revenue Revenue Growth (%) 11.1 (0.8) EBITDA EBITDA Margins (%) PAT (normalized) EPS (Rs.) Capex (1975) (2210) (2271) (2021) Net CFO Net Debt (1293) (1677) (2420) (2686) Free Cash Flow We expect the revenue to grow at a CAGR of 14.6% during FY16-FY18E. The growth is partially contributed by volume growth and partially due to impact of new accounting standards (Ind-AS). EBITDA is likely to grow at a CAGR of 21.5% over FY16-FY18E. We expect EBITDA margins to improve due to fall in natural gas prices. PAT is expected to grow at a CAGR of 23.8% over FY16-FY18E and PAT margin is expected to improve due to high volume growth and declining cost. 13

14 Exhibit 21: Revenue & Revenue Growth % 20.6% 15.7% 11.1% 8.8% -0.8% FY13 FY14 FY15 FY16 FY17E FY18E 30% 20% 10% 0% -10% Revenue (Rs. Mn) Revenue Growth (%) The sales of the company grew at a CAGR of 12.3% during FY12-FY16. In FY16, the sales registered de-growth of -0.8% mainly due to fall in demand and realisations. Going forward, we expect total sales of the company to grow at a CAGR of 10.2% over FY16-FY18E mainly led by higher volume growth and new accounting policy impact. Exhibit 22: EBITDA & EBITDA Margin % 27.8% 25.9% 24.7% 25.2% 23.4% FY13 FY14 FY15 FY16 FY17E FY18E 35% 25% 15% EBITDA (Rs. Mn) EBITDA Margin (%) The EBITDA margins of the company have declined in past with marginal or no growth in EBITDA. However, in FY16, the company reported 4.7% growth and improvement in margins. The EBITDA margins improved from 23.4% in FY15 to 24.7% in FY16. Going forward, with decline in natural gas prices, we expect the EBITDA margins of the company to further improve to 25.2% and 27.8% in FY17E and FY18E respectively. Exhibit 23: PAT & PAT Margin % 17.3% 15.8% 14.9% 15.2% 14.4% FY13 FY14 FY15 FY16 FY17E FY18E 20% 18% 16% 14% 12% 10% PAT (Rs. Mn) PAT Margins (%) The net profit of the company has also stayed flat with 2.6% YoY growth in FY16 and margins have declined over the years. However, going forward, we expect the company to report CAGR growth of 23.8% in PAT over FY16-FY18E and PAT margins to improve to 15.2% and 17.3% in FY17E and FY18E respectively. Exhibit 24: Dividend Per Share FY13 FY14 FY15 FY16 FY17E FY18E Dividend Per Share (Rs.) The company has good track record of paying dividends and we expect it to continue going forward. From FY13-FY16, each year company paid dividend of Rs per share resulting into dividend payout ratio of 50% on average. 14

15 Exhibit 25: RoE & RoCE 40% 36.7% 33.1% 33.1% 35% 30.7% 29.6% 36.1% 30% 25% 26.5% 24.0% 22.3% 21.1% 23.6% 25.7% The company has a track record of healthy RoE and RoCE ratios. Going forward, we expect the return ratios improve in FY17E and FY18E. 20% FY13 FY14 FY15 FY16 FY17E FY18E RoE (%) RoCE (%) Exhibit 26: Operating & Free Cash Flow FY13 FY14 FY15 FY16 FY17E FY18E Operating Cash flow (Rs. Mn) Free cash flow (Rs. Mn) The operating cashflow and free cash flow are expected to improve with increase in sales and expansion of margins. Exhibit 27: Company Snapshot (Ratings) Low High Quality of Earnings 33 Domestic Sales 33 Exports 33 Net Debt/Equity 33 Working Capital Requirement 33 Quality of Management 33 Depth of Management 33 Promoter 33 Corporate Governance 33 15

16 Valuation & Outlook Mahanagar gas is one of the largest players in the CGD industry with operations in Mumbai and adjoining areas. The company has zero debt, healthy margins and return ratios. At CMP of Rs. 608, it is trading at 12.7x FY18E EPS. We value the company at 16x FY18E EPS and initiate coverage on the company with BUY rating, for a price target of Rs. 766, representing an upside of 26% for a period of 9-12 months. Exhibit (a): Comparative Valuation Summary CMP (Rs.) Mcap (Rs. Mn) EV/EBITDA (x) P/E (x) EPS (Rs.) FY15 FY16 FY17E FY18E FY15 FY16 FY17E FY18E FY15 FY16 FY17E FY18E Indraprastha Gas Ltd Source: Bloomberg, Karvy Research Exhibit (b): Comparative Operational Metrics Summary CAGR % (FY16-18E) RoE (%) Price Perf (%) Net Sales (Rs. Mn) Sales EBITDA EPS FY15 FY16 FY17E FY18E 3m 6m 12m FY15 FY16 FY17E FY18E NA NA NA Indraprastha Gas Ltd Source: Bloomberg, Karvy Research, NA: Not Applicable Key Risks yadverse movement in domestic natural gas prices / R-LNG prices/crude oil prices. yunfavourable regulations from MoPNG and PNGRB. yuncertainty over Marketing exclusivity by PNGRB. ydelays in expansion and completion of expansion plans. 16

17 Financials Exhibit 28: Income Statement YE Mar (Rs. Mn) FY14 FY15 FY16 FY17E FY18E Revenues Growth (%) (0.8) Operating Expenses EBITDA Growth (%) Depreciation & Amortization Other Income EBIT Interest Expenses PBT Tax Adjusted PAT Growth (%) (0.4) Exhibit 29: Balance Sheet YE Mar (Rs. Mn) FY14 FY15 FY16 FY17E FY18E Cash & Bank Balances Sundry Debtors Inventory Loans & Advances Gross Block Net Block CWIP Miscellaneous Total Assets Current Liabilities & Provisions Debt Other Liabilities Total Liabilities Shareholders Equity Reserves & Surplus Total Networth Total Networth & Liabilities

18 Exhibit 30: Cash Flow Statement YE Mar (Rs. Mn) FY14 FY15 FY16 FY17E FY18E PBT Depreciation Interest Tax Paid (1286) (1390) (1501) (1939) (2349) Inc/dec in Net WC Other Income (283) (317) (254) (492) (610) Other non cash items 17 9 (19) 0 0 Cash flow from operating activities Inc/dec in capital expenditure (1768) (1975) (2210) (2271) (2021) Others (231) (633) (76) 492 (1090) Cash flow from investing activities (1999) (2607) (2286) (1779) (3111) Inc/dec in borrowings (19) 76 (18) 66 (15) Dividend paid (1829) (1829) (1882) (2081) (2081) Interest paid (4) (8) (15) (25) (35) Cash flow from financing activities (1852) (1761) (1914) (2040) (2131) Net change in cash 126 (101) Exhibit 31: Key Ratios YE Mar FY14 FY15 FY16 FY17E FY18E EBITDA Margin (%) EBIT Margin (%) Net Profit Margin (%) Dividend Payout Ratio (%) Debt/Equity (x) RoE (%) RoCE (%) Exhibit 32: Valuation Parameters YE Mar FY14 FY15 FY16 FY17E FY18E EPS (Rs.) DPS (Rs.) BVPS (Rs.) PE (x) P/BV (x) EV/EBITDA (x) EV/Sales (x)

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