State-Owned City Gas Cos IGL, MGL & Gujarat Gas Share Price Plummet Amid Likely Gas Allocation Cuts

The shares of major city gas distribution (CGD) companies, including Indraprastha Gas Limited (IGL) and Mahanagar Gas Limited (MGL), saw significant declines of up to 15% on October 18 following the government's announcement of a sharp reduction in priority gas allocation to CGDs. The allocation has been cut to approximately 50%, down from around 70%, raising concerns about the profitability of these companies.

Allocation Cut

The recent reduction is the largest single cut in gas allocations under the Administered Price Mechanism (APM) for CGDs, which had already experienced a sustained decline from over 85% at the start of FY24 to around 72% now. The government's decision to lower the allocation has triggered alarm among investors, resulting in substantial selling pressure on the stocks of key players in the CGD sector.

Impact on Profitability

The cut in gas allocation is expected to have a material impact on the profitability of CGD companies, as natural gas is a crucial raw material for their operations. With the government reducing the domestic natural gas allocation to these firms by 20%, they will now be required to source the remaining gas through imports. This imported gas is priced at 50-60% higher than domestic gas, which could significantly squeeze profit margins unless companies decide to pass on these costs to consumers.

Analysts estimate that IGL, MGL, and Gujarat Gas will need to increase Compressed Natural Gas (CNG) prices by around Rs 6 per kilogram to maintain their margins. However, any price hike could adversely affect sales volumes, creating a dilemma for these companies.

If the companies choose not to raise prices, analysts predict a significant earnings impact, estimating a 32% decline for IGL, a 20% drop for MGL, and a 24% reduction for Gujarat Gas. This situation poses a challenging landscape, particularly in light of upcoming assembly elections, which could limit the likelihood of a price increase due to political sensitivities.

Global brokerage firm Jefferies has pointed out that the reallocation of 12-15% of APM gas for city gas distributors means these companies will now have to rely more on spot or short-term Liquefied Natural Gas (LNG) purchases to meet demand. This transition is projected to further impact EBITDA margins, reducing them by Rs 3 for IGL, Rs 3 for MGL, and Rs 2.3 for Gujarat Gas.

As reliance on market-linked gas continues to grow, CGD companies may face the difficult choice of prioritizing profit margins over volume growth. This shift in strategy could lead to a derating of the sector, according to Jefferies, which plans to reassess its estimates following any pricing adjustments made by these companies.

CGD companies will likely have to pass on most, if not all, of the increased gas costs to consumers, as failing to do so could severely impact their profit margins. JM Financial noted that raising CNG prices by Rs 3.5 to Rs 5 per kilogram, or 5-7%.

The brokerage also highlighted that this situation could weaken pricing power in the CNG sector, posing significant risks to both volume growth and profit margins. Consequently, JM Financial has downgraded its ratings for IGL and MGL to 'sell,' setting target prices of Rs 435 and Rs 1,400, respectively, which suggests a potential decline from their current levels.

As of 11:45 am on October 18, the share prices reflected the market's concerns. IGL shares traded down nearly 11% at Rs 451, while Mahanagar Gas shares were down over 12% at Rs 1,549.70. Gujarat Gas, another major player, also faced pressure, but with a more modest decline, trading just 1% lower at Rs 564.60.