Mahanagar Gas: Three reasons why investors can accumulate this stock

Investors with a two to three year horizon may consider accumulating the shares of Maharashtra-based natural gas distribution company Mahanagar Gas (MGL). Sponsored by GAIL and the Government of Maharashtra, MGL serves the pipeline natural gas (residential and industrial) and compressed natural gas (auto) needs of the Mumbai metropolitan area and adjacent areas.

The company is also expanding its presence in Maharashtra and is also making inroads into neighboring states such as Karnataka through the acquisition of Unison Enviro Private Limited (UEPL), which will help the company to sustain growth in the medium term. Also, Kirit Parikh’s report on the review of the decision to raise the price of natural gas, if adopted by the government, will bode well for MGL’s profits. At the current price of £985, the stock is trading at 14.9 times its last 12-month gains.

Important positive aspects

We believe MGL is a good investment option for investors with a moderate risk appetite for three reasons.

First, the company, which has a strong presence in the greater Mumbai area, is now expanding its geographical area. MGL currently serves 2.1 million homes through its pipeline natural gas (PNG) infrastructure. Likewise, the PNG business supports over 4,106 small commercial enterprises and over 382 industrial customers that use gas as a raw material or fuel. In the compressed natural gas (CNG) segment, the company refuels over 0.91 million vehicles. The company also supplies over 301 petrol stations.

MGL has three Geographical Areas (GAs) in Mumbai, Thane Urban and Raigad. The £5.31bn acquisition of Unison will help the company add more GAs – Ratnagiri, Latur and Osmanabad (Maharashtra) and Chitradurga and Davanagare (Karnataka). Unison had sales of approximately £90m in FY22. With around 72 additional CNG filling stations, the acquisition should contribute to the company’s growth in the medium term. In addition, with net cash on the books of £200bn and therefore no leverage concerns, MGL is well positioned to take advantage of consolidation opportunities in the CGD (City Gas Distribution) space. This was the Company’s first acquisition and it is expected that MGL will continue to pursue inorganic growth opportunities going forward.

Second, given the unprecedented rise in global energy prices in 2022 thanks to the Russia-Ukraine crisis, the government had to increase domestic gas prices in line with the global trend. The increase in Administered Pricing Mechanism (APM) gas price from March 2022 from $2.9 per mmBtu to $6.1 led to a weakening of profitability in 2022-23. Operating profit margin fell from 43 percent in FY21 to 17 percent for the nine-month period December 2022. In addition to higher costs, companies could not fully pass on increased input costs to end customers due to inflationary pressures. However, with three price increases in April, October and November 2022, the company is better positioned to maintain profitability going forward. From ₹65 per kg in March 2022, the CNG price rose to ₹72 in April and further to ₹86 in October and ₹89.5 in November last year. The full benefit of the price increases should start flowing in the January-March 2023 quarter.

Additionally, the 2022 Kirit Parikh Committee Recommendation recommended a price cap for APM gas supplied to CGD players such as MGL. If that happens, it will further help MGL’s margins. While the market has already factored in higher APM gas prices and the consequent drop in margins, any positive development in the Kirit Parekh report will have an increasingly positive impact on the company’s profitability and also on the share price.

Third, the company’s strong balance sheet with no debt and healthy returns of around 20 percent — both return on equity and return on capital employed — are positives. This gives the company ample legroom to grow inorganically. This can be an extra growth spurt. The company is a consistent dividend payer with a current yield of around 2.5 percent. The stock also looks interesting on a valuation front at current levels, trading at 14.9 times its last 12-month earnings. Given that the stock is up almost 18 percent on a YTD basis, investors can take advantage of any declines to accumulate the stock.

In the period April to December 2022, MGL managed to increase sales by 90 percent thanks to the price increases. However, operating profit grew more slowly, by 12 percent, due to higher costs – APM gas prices. This resulted in a decline in operating profit margin from 29 percent in 9MFY22 to 17 percent in 9MFY23. But now with the next round of price increases in November 2022, margins should stabilize and gradually improve from here.

pain points

While we do not expect APM gas prices to increase significantly in the near term, any unexpected increase in gas prices could further threaten MGL’s profitability. Also, CNG volume growth was a tepid 3-5 percent, with sales also growing in the single digits; Higher prices may also narrow the spread between gasoline, diesel and CNG and may not support the switch to CNG, hampering volume growth. However, this may be mitigated by strong demand in the pipeline gas segment. While we do not expect any short-term impact from EVs, the medium to long-term prospects of CNG may depend on the uptake of EVs in India. However, we do not see any significant risks for MGL’s existing business. Mahanagar Gas: Three reasons why investors can accumulate this stock

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