HDFC Securities Upgrades Mahanagar Gas to Buy

HDFC Securities has upgraded its rating on Mahanagar Gas Ltd (MGL) to Buy from Add, citing an attractive valuation for the city gas distribution company in light of recent correction in its price.

HDFC Sec has set a target price of Rs 1,210 per share on MGL, about 18% higher than the current market price of Rs 1,030. The brokerage believes the risk-reward is favorable for MGL at current levels.

Stock Correction

MGL is one of India’s leading city gas distribution companies, supplying CNG and PNG in Mumbai, its adjoining areas and Raigad district of Maharashtra.

MGL’s stock price has corrected around 12% from its August peak, largely driven by disappointing volume growth. CNG volumes rose just about 1% year-on-year in the June 2022 quarter while PNG volumes were flat.

Overall sales volume growth was muted at 0.8% YoY during the quarter. Lower volumes were on account of elevated prices of CNG and domestic PNG which dampened demand.

HDFC Securities highlighted that MGL is currently trading at 9.8 times estimated earnings for September 2024, a steep 24% discount to its five-year average P/E multiple of 12.9 times. The current market price implies muted volume growth of just 2.5% going ahead.

Growth Expectations

However, HDFC Securities believes MGL’s volume growth will pick up gradually on the back of multiple factors.

Firstly, the implementation of the Kirit Parikh committee’s recommendations from April 2023 should provide some respite from high gas costs for CGD companies like MGL. This will offer room for reducing CNG and PNG prices, thereby reviving volume growth.

Secondly, a decline in gas prices is likely with the production from new high-pressure high-temperature fields of ONGC and RIL coming onstream in H2FY24.

Besides, the gap between CNG and petrol/diesel prices can potentially widen further in MGL’s geographical areas as crude oil prices have increased sequentially. This will make CNG more economical compared to liquid fuels.

MGL is also targeting connecting 3 lakh domestic PNG connections every year. Addition of more industrial and commercial clients will further aid PNG volume growth.

The company’s recent acquisition of three geographical areas from Unison Enviro should boost volumes by 1 mmscmd over 8-10 years. HDFC Securities estimates MGL’s volumes rising to 3.5 mmscmd in FY24 and 4 mmscmd by FY26.

Attractive Valuation

The brokerage has marginally raised its earnings estimates for FY24-26 after factoring in the volume contribution from Unison Enviro’s acquired areas.

HDFC Securities expects MGL to maintain its industry-leading EBITDA margins given the scope for further cuts in CNG and PNG realizations.

MGL reported the highest-ever unit EBITDA margin of Rs 16.8 per scm in Q1FY24, aided by lower gas costs. The brokerage forecasts EBITDA margin per scm to remain strong at Rs 12 in FY24 despite some price reductions going ahead.

Overall, HDFC Securities believes the current valuation of 9.8x FY24 EPS offers an attractive entry point for long-term investors to accumulate the stock. MGL remains well placed to capitalize on the enormous potential for gas demand in its areas of operation.

As of Q1FY23, the company served ~1.5 million CNG vehicles through 241 stations and over 1.3 million domestic, industrial and commercial PNG connections.

MGL reported a 7% YoY rise in total income to Rs 1,174 crore and 3% growth in net profit to Rs 204 crore in Q1FY23.

The company is a joint venture between state-run GAIL India Ltd, UK’s BG Group and the Maharashtra government. MGL gets majority of its gas supply from GAIL under a long-term contract valid until April 2026.