retail equity research mahanagar gas ltd. accumulate

23rd June, 2017

Exclusive rights to distribute gas in Mumbai

MGL is the sole authorised distributor of compressed natural gas (CNG) and piped natural gas (PNG) in Mumbai & its adjoining areas. Further, the company has expanded its operations to supply natural gas to Raigad district of Maharashtra. The company has exclusive authorisation to lay, build, expand and operate the city gas distribution (CGD) network in Mumbai and its adjoining areas for a period of 25 years. This infrastructure exclusivity is valid until 2020/2030/2040 for Mumbai/adjoining areas/Raigad district. This provides the company a competitive edge over peers in its area of operations.

Volume growth momentum to sustain The demand of natural gas for CGD in India is expected to remain buoyant on the back of favorable government policy and promising economics of CNG usages vis-a-vis alternative fuels. Driven by the benefit of low cost CNG, the conversions have been strong at ~1.2 lakh annually. Further, the government is undertaking several initiatives to spur demand of natural gas including setting up of approximately 15,000 kms of new gas transmission pipeline, expanding into newer cities and extending support on gas allocation to priority sector. Further, expected growth in the number of CNG operated vehicles and potential rise in the usage of PNG will drive growth. Given MGL’s strong presence in Mumbai & commencement of gas supply in the Raigad district coupled with new City Taxi Guidelines 2016, it is well positioned to leverage this growth momentum. We factor CNG/PNG volume CAGR of ~9%/10% over FY17-19E. Healthy financial profile MGL has a strong balance sheet with healthy free cash flow, sustainably high return on equity and negligible debt levels. Despite annual capex requirement of ~Rs200cr over FY13-17, the company has generated free cash flow (FCF) to the tune of ~Rs900cr during the period. Further, we expect the cashflows to strengthen going ahead led by strong profitability (FCF of ~Rs500cr over FY17-19E). Notably, the company continues to register strong return ratios with RoEs/RoCE in excess of 20%/30%. The robust balance sheet provides MGL the financial flexibility to expand its network.

Valuations Strong demand coupled with government’s push for the adoption of natural gas bodes well for MGL. Further its scalable business model (exclusivity rights in Mumbai & adjacent areas), superior return ratios and strong dividend payout (~50%) will continue to drive re-rating in the stock. The stock currently trades at 22.8x/20.4x FY18E/19E EPS. We expect revenue/PAT to grow at a CAGR of 14%/10% over FY17-19E. Hence, we value the stock at 23x FY19E EPS arriving at a target price (TP) of Rs1,114.

RETAIL EQUITY RESEARCH

Mahanagar Gas Ltd. Rating as per Mid Cap 12 month period Gas

BSE CODE: 539957 NSE CODE: MGL CMP Rs988 TARGET Rs1114 RETURN 13%

Bloomberg CODE: MAHGL:IN SENSEX: 31,291

Company Data

Market Cap (cr) Rs9,759

Enterprise Value (cr) Rs9,285

Outstanding Shares (cr) 9.9

Free Float 35%

Dividend Yield 1.9%

52 week high Rs1,053

52 week low Rs493

6m average volume (lacs) 1.8

Beta 0.9

Face value Rs10

Shareholding % Q2 FY17 Q3 FY17 Q4 FY17

Promoters 65.0 65.0 65.0

FII’s 9.8 11.3 9.8

MFs/Insti 15.4 17.6 18.0

Public 4.7 4.7 5.6

Others 5.1 1.4 1.6

Total 100.0 100.0 100.0

Price Performance 3mth 6mth 1 Year

Absolute Return 11% 29% -

Absolute Sensex 7% 20% -

Relative Return* 4% 9% - *over or under performance to benchmark index

Y.E Mar (Rs cr) FY17 FY18E FY19E

Sales 2,034 2,327 2,653

Growth (%) -2.2% 14.4% 14.0%

EBITDA 644 688 768

EBITDA Margins % 31.7% 29.6% 28.9%

PAT Adj. 393 428 478

Growth (%) 27.4% 8.8% 11.8%

Adj.EPS 39.8 43.3 48.4

Growth (%) 27.4% 8.8% 11.8%

P/E 24.8 22.8 20.4

P/B 5.3 4.8 4.3

EV/EBITDA 14.9 13.9 12.3

ROE (%) 23.4 22.0 22.0

D/E 0.0 0.0 0.0

COMPANY INITIATING REPORT

ACCUMULATE

Strong growth prospects… Mahanagar Gas Limited (MGL), a joint venture between GAIL (India) Ltd and BGAPH (a subsidiary of Royal Dutch Shell Plc), is one of India's leading natural gas distribution companies. Currently, MGL has a supply network of over 4,838 kms of pipeline and 203 CNG filling stations.

• MGL is the third largest natural gas distribution company in India. Notably, it is the sole authorised distributor of CNG and PNG in Mumbai & its adjoining areas.

• CNG penetration in Mumbai is relatively low at 25-30% vs Delhi which is at 35-40%. This leaves a lot of headroom for growth for the company.

• MGL enjoys the benefit of strong parentage as it is promoted by both GAIL (India) Ltd and BGAPH (a subsidiary of Royal Dutch Shell Plc)

• MGL’s EBITDA/scm is expected to decline to Rs6.75 in FY18E from Rs6.89 in FY17. However, the same is estimated to improve to Rs6.92 in FY19E.

• Revenue/PAT to grow at 14%/10% CAGR over FY17-19E due to uptick in volume growth.

• We value the stock at 23x FY19E EPS arriving at a target price (TP) of Rs1,114.

Valuations At CMP, the stock is quoting at P/E multiple of 20.4x FY19E earnings versus a range of 17x to 44x for leading gas distribution companies. We assign a target multiple of 23x to FY19E EPS of Rs48.4 and arrive at a target price of Rs1,114. The target multiple is in line Indraprastha Gas Ltd (IGL) which has a similar business model. While MGL owns exclusive rights of distribution of CNG & PNG in Mumbai, its adjoining areas & Raigad district, IGL has exclusive rights in Delhi & NCR regions. Importantly, CNG penetration in Mumbai at 25-30% is relatively lower when compared to Delhi at 35-40%. Furthermore, MGL boasts of a strong balance strength with healthy free cash flow, superior return ratios with RoEs in excess of 20% and negligible debt levels. As the Mumbai gas distribution market is hugely under-penetrated, MGL is increasing its penetration in Mumbai & its adjoining areas for CNG, domestic PNG, commercial PNG and industrial PNG. This augurs well for the volume growth going ahead.

1 Yr fwd P/E band

Peer comparison

Company Sales (cr) EBITDA Margin %

FY17 FY18E FY19E FY17 FY18E FY19E

MGL 2,034 2,327 2,653 31.7 29.6 28.9

IGL 3,815 4,318 4,862 - 24.7 23.8

GUJGAS 5,093 6,827 7,255 15.1 16.5 17.6

Company P/E ROE%

FY17 FY18E FY19E FY17 FY18E FY19E

MGL 24.8 22.8 20.4 23.4 22.0 22.0

IGL 27.1 23.6 21.1 - 20.3 19.6

GUJGASz 48.7 25.5 20.4 11.71 20.0 21.4 Source: Bloomberg, Geojit Research

Investment Rationale Sole player in gas distribution in Mumbai

MGL is the sole authorised distributor of CNG & PNG in Mumbai and its adjoining areas. Mumbai being a

growing commercial and financial hub, provides incremental opportunities to capture the demand for natural gas from domestic customers as well as commercial sector. Further, the company has expanded its operations to supply natural gas to Raigad district of Maharashtra. The company has identified six pockets in Raigad for suppling natural gas. The supply of PNG & CNG is expected to commence in FY18.

Given the low-cost advantage, stringent environmental norms & large untapped potential, CNG market is poised for growth. Driven by the benefit of low cost, the conversions have been strong at ~1.2 lakh annually. Moreover, the new city taxi guidelines 2016 mandates all app-based taxis to run on cleaner fuel. As of now, only 50% of taxis are plying on CNG. Currently, MGL’s penetration into CNG vehicles space in Mumbai region is 30%, thus providing a huge scope for the company. Hence, we expect the company’s CNG volumes to register a CAGR of ~8% over FY17-19E.

The company currently has a PNG customer base of ~9 lakh and has added close to 3.5 lakh customers over the last five years. We expect the strong momentum to continue and project volume CAGR of 10% over FY17-19E.

As of March 31, 2016, the company has 57 CNG filling stations out of overall 188 CNG filling stations and 0.27 mn domestic PNG customers out of 0.86 million customers in the adjoining areas.

Break-up of CNG filling stations Type of CNG filling stations No. of stations as

of FY16

Owned by company 13

Owned by:

BPCL 53

HPCL 54

IOCL 29

Owned by other private and other parties 39

Total 188

Source: Company, Geojit Research

MGL’s customer base

FY13 FY14 FY15 FY16 FY17

CNG (in

‘000s) 285.5 359.1 421.3 470.5 545.5

PNG (in

‘000s) 643.5 708.6 804.0 865.2 952.2


Focus on expanding presence to enhance customer base Over the last five years, the company has set up 2 City Gate Stations (CGSs), 43 CNG filling stations, laid down 114.33 kms of steel & 1,243 kms of Polyethylene (PE) pipeline (including medium and low pressure PE network) and added 0.35 million PNG customers. Currently the company is having 203 CNG filling stations (owned by MGL is 14), over 4,838 kms of pipeline, 4 CGS and CNG & PNG customer base of ~0.54 million & ~0.94 million respectively. Further, continuing its expansion spree, the company is planning to expand its operations both in the existing areas and new markets which will lead to improvement its reach and customer base. MGL is planning to increase its steel & PE pipeline network by more than 675 kms and will add 83 CNG filling stations during the next five years. Besides, the company is also seeking to enter into new markets by participating in the bidding process for new city gas distribution projects as well as through inorganic growth.

Strong entry barriers provide a competitive edge

The company has a rich experience of more than 20 years in building and operating its CGD network in Mumbai and its adjoining areas. The company has exclusive authorisation to lay, build, expand and operate the CGD network in Mumbai and its adjoining areas for a period of 25 years. This infrastructure exclusivity is valid until 2020 for Mumbai, until 2030 for the adjoining areas and until 2040 for the Raigad district. The period of exclusivity is extendable in blocks of 10 years as per the PNGRB regulations. This exclusivity benefit mandates a new operator to only use the company’s distribution network upon the payment of transportation tariff. Taking into consideration, the company’s infrastructure exclusivity coupled with lead time in procuring domestic natural gas, the requirement of regulatory approvals and high capex in setting up of CGD network, this provides the company a competitive edge over peers in its area of operations.

Secured fuel supplies

The company sources most of its natural gas requirement from GAIL as per the long term agreement between the two parties. The price of domestic natural gas is determined by the administered price mechanism (APM). While the company secures 94% of the total natural gas requirement through long term and mid-term contracts with GAIL, the balance is met through

spot contracts with RLNG suppliers, including GAIL. The company sources natural gas from GAIL under three agreements viz; Domestic Natural Gas agreement, Panna Mukta & Tapti agreement and Gas Sales agreement. The company receives 0.5 mmscmd of natural gas as per the Panna Mukta and Tapti agreement and 1.67 MMSCMD is sourced pursuant to the domestic natural gas agreement. Further, it has also entered into the gas sale agreement with GAIL for supply of 0.15 MMSCMD of RLNG on a firm basis and 0.15 MMSCMD of RLNG on a fallback basis. The company also procures RLNG for meeting the requirements of industrial and commercial PNG, i.e., non-priority sector from other domestic sources like GAIL, HPCL, BPCL, among others, both on term and spot basis.

Long term and mid-term contracts with GAIL for the procurement of natural gas

Gas Sourcing Agreements

Supply Source

Present Gas Allocation/Contract

ed Quantity (MMSCMD)

Maximum Permissible Availability (MMSCMD)

Domestic Natural Gas Agreement

Allocated by Government

1.67 Up to 1.83 (110% of

allocation)

PMT Agreement

PMT (Allocated by Government)

0.50 Up to 0.55 (110% of

allocation)

GS Agreement

Term RNLG with GAIL

0.15 on a firm basis 0.15 on a fallback basis


Volumes of natural gas purchased from GAIL (MMSCMD)


Promising long-term growth prospects for CGD

The demand of natural gas for city gas distribution (CGD) in India is expected to remain buoyant on the back of favorable government policy and promising

economics of CNG usage vis-a-vis alternative fuels. In addition to this, increasing pace of gas networks in newer geographies coupled with increased use of PNG in domestic, industrial and commercial sectors will drive growth going ahead. Priority allocation of domestic gas to CNG and PNG coupled with development of CNG grid bodes well for the sector.

Besides, the government’s thrust on promoting CGD sector in India also augurs well for the sector. The government plans to set up approximately 15,000 kilometres of new gas transmission pipelines, expansion into newer cities and extend support on gas allocation to priority sector. In February 2014, the government increased allocation of natural gas to CGD companies to 100%. Further, in August 2014, the government revised the allocation to 110% requirement of each CGD entity for supply to the priority sector.

Given MGL’s strong presence in Mumbai and commencement of gas supply in Raigad district, we believe it is better placed to leverage this growth momentum. The company has exclusivity of natural gas distribution in Mumbai until 2020, its Adjoining Areas until 2030 and the Raigad district until 2040.

CGD Demand: Priority Sector and Non-Priority Sector


Financials

Sturdy volume growth and geographical expansion to provide impetus to revenue growth

MGL’s revenue has grown at a CAGR of ~8% over FY13-17 owing to healthy growth in volumes & realisation. Volume growth during the period under consideration grew by ~5% CAGR backed by healthy growth in CNG and domestic PNG volumes. Further, ~2% CAGR growth in realisation during the period under review also aided to revenue growth. Going ahead, we expect the revenue to grow at a CAGR of 14% during FY16-19E mainly driven by uptick in volume growth.

Overall revenue to grow at ~8% CAGR during FY16-19E


EBITDA margin to remain healthy Owing to its exclusivity of gas distribution rights in Mumbai & adjacent areas coupled with the benefit of passing on the increase in the cost of natural gas to its customers has enabled MGL to sustain its EBITDA margin above 20% over FY13-17. Going forward, we expect EBITDA margin to ease to 29.6%/28.9% in FY18E/19E on account of higher fuel costs.

EBITDA to grow at 9% CAGR over FY17-19E


PAT to improve by 10% CAGR during FY17-19E Adjusted net profit grew modestly by 7% CAGR over FY13-16. We expect Adj. PAT to witness a CAGR of 10% largely in-line with robust sales growth.

PAT to grow at 10% CAGR over FY17-19E


Healthy balance sheet

MGL enjoys a strong balance strength with healthy free cash flow, sustainably high return on equity and negligible debt levels. Despite annual capex requirement of ~Rs200cr over FY13-17, the company continues to generate healthy FCF to the tune of ~Rs900cr during the period. Further, we expect the cashflows to strengthen going ahead led by strong profitability (FCF of ~Rs500cr over FY17-19E). Further, the company continues to register strong return ratios with return of equity (ROE) of more than 20% and return on capital employed of over 30%. Further, we expect ROE & ROCE to remain healthy at 22% and ~33% respectively in FY19E led by healthy free cash flow generation. The company has good track record of paying dividends as it consistently maintained dividend of more than Rs. 15 per share translating into dividend payout of over ~50% over FY13-17. We expect the company to sustain its robust dividend payout going ahead. Given its robust balance strength, we believe this will aid the company in providing the financial flexibility to expand its network.

RoE to remain above 20%, led by strong free cash flow generation


Mahanagar Gas Ltd: Business overview Incorporated in 1995, Mahanagar Gas Limited (MGL) is one of India's leading natural gas distribution companies. MGL is a joint venture between GAIL (India) Ltd and BGAPH (a subsidiary of Royal Dutch Shell Plc). It operates primarily in Mumbai and adjoining areas. It is the sole authorised distributor of compressed natural gas (CNG) and piped natural gas (PNG). MGL supplies CNG to ~0.54mn vehicles through the network of over 203 CNG filling stations. It also

supplies PNG connection to more than 0.94mn/~3,000 /220 domestic households/commercial/ industrial consumers. MGL has a robust supply network of over 4,838 kms of pipelines as of March 31, 2017.

MGL’s sales break-up


Sales volume mix (In MMSCMD)


Key Risks: • Any uptick in the cost price of natural gas.

• Reduction in allocation amount of domestic natural gas from MoPNG.

• Alternative fuels becoming more cost effective.

• Adverse exchange rate fluctuations.

Standalone Financials

Profit & Loss Account

Y.E March (Rs cr) FY15A FY16A FY17A FY18E FY19E

Sales 2,095 2,079 2,034 2,327 2,653

% change 11.1% -0.8% -2.2% 14.4% 14.0%

EBITDA 490 513 644 688 768

% change 0.3% 4.7% 25.6% 6.9% 11.5%

Depreciation 80 84 95 106 121

EBIT 410 429 549 582 647

Interest 1 3 1 0 -

Other Income 41 43 53 67 78

PBT 449 469 601 649 725

% change 1.7% 4.3% 28.2% 8.0% 11.8%

Tax 148 160 207 221 246

Tax Rate (%) 33.0% 34.1% 34.5% 34.0% 34.0%

Reported PAT 301 309 393 428 478

Adj.* - - - - -

Adj. PAT 301 309 393 428 478

% change 1.3% 2.6% 27.4% 8.8% 11.8%

No. of shares (cr) 8.9 8.9 9.9 9.9 9.9

Adj EPS (Rs) 30.5 31.3 39.8 43.3 48.4

% change -8.4% 2.6% 27.4% 8.8% 11.8%

DPS (Rs) 17.5 17.5 19.0 19.0 19.0

Cash flow

Y.E March (Rs cr) FY15A FY16A FY17A FY18E FY19E

Pre-tax profit. 449 469 601 649 725

Depreciation 80 84 95 106 121

Changes in W.C 14 4 (88) 3 1

Others 22 19 (92) (67) (78)

Tax paid (139) (150) (207) (221) (246)

C.F.O 427 425 309 471 522

Capital exp. (198) (221) (223) (250) (250)

Change in inv. (28) (13) (78) - -

Other invest.CF (35) 5 53 67 78

C.F - investing (261) (229) (249) (183) (172)

Issue of equity - - 9 - -

Issue/repay debt (2) (2) (2) (1) (1)

Dividends paid (183) (188) (225) (225) (225)

Other finance.CF 9 (1) 133 (0) -

C.F - Financing (176) (191) (84) (227) (227)

Chg. in cash (10) 5 (24) 61 124

Closing cash 145 172 148 209 333

Balance Sheet Y.E March (Rs cr) FY15A FY16A FY17A FY18E FY19E

Cash 145 172 148 209 333

Accounts Receivable 96 89 95 108 123

Inventories 17 18 24 28 33

Other Cur. Assets 61 56 63 70 77

Investments 371 388 467 467 467

Gross Fixed Assets 1,671 1,845 2,085 2,347 2,697

Net Fixed Assets 1,064 1,160 1,305 1,460 1,689

CWIP 380 429 412 400 300

Intangible Assets - - - - -

Def. Tax (Net) (103) (118) (138) (138) (138)

Other Assets 31 44 112 112 112

Total Assets 2,063 2,238 2,487 2,716 2,995

Current Liabilities 622 700 630 657 685

Provisions - - - - -

Debt Funds 25 4 3 1 -

Other Liabilities 8 6 14 14 14

Equity Capital 89 89 99 99 99

Reserves & Surplus 1,318 1,439 1,741 1,944 2,197

Shareholder’s Fund 1,407 1,528 1,840 2,043 2,296

Minority Interest - - - - -

Total Liabilities 2,063 2,238 2,487 2,716 2,995

BVPS (Rs) 157.5 171.0 186.3 206.8 232.4

Ratios

Y.E March FY15A FY16A FY17A FY18E FY19E

Profitab. & Return EBITDA margin (%) 23.4 24.7 31.7 29.6 28.9

EBIT margin (%) 19.6 20.6 27.0 25.0 24.4

Net profit mgn.(%) 14.4 14.8 19.3 18.4 18.0

ROE (%) 22.3 21.0 23.4 22.0 22.0

ROCE (%) 32.9 31.8 35.7 33.4 33.4

W.C & Liquidity Receivables (days) 15.4 14.3 15.4 15.4 15.4

Inventory (days) 4.2 4.5 6.9 6.9 6.9

Payables (days) 25.5 26.1 39.1 39.1 39.1

Current ratio (x) 0.5 0.5 0.5 0.6 0.8

Quick ratio (x) 0.5 0.5 0.5 0.6 0.8

Turnover &Levg. Gross asset T.O (x) 1.3 1.2 1.0 1.0 1.1

Total asset T.O (x) 1.0 0.9 0.8 0.8 0.9

Adj. debt/equity (x) 0.0 0.0 0.0 0.0 0.0

Valuation ratios EV/Net Sales (x) 4.2 4.2 4.7 4.1 3.6

EV/EBITDA (x) 17.8 16.9 14.9 13.9 12.3

P/E (x) 32.4 31.6 24.8 22.8 20.4

P/BV (x) 6.3 5.8 5.3 4.8 4.3

Recommendation Summary

Dates Rating Target

23-June-2017 Accumulate 1,114

Source: Bloomberg, Geojit BNP Paribas Research

Large Cap Stocks; Mid Cap and Small Cap;

Buy - Upside is 10% or more. Hold - Upside or downside is less than 10%. Reduce - Downside is 10% or more.

Buy - Upside is 15% or more. Accumulate* - Upside between 10% - 15%. Hold - Absolute returns between 0% - 10%. Reduce/Sell - Absolute returns less than 0%. To satisfy regulatory requirements, we attribute ‘Accumulate’ as Buy and ‘Reduce’ as Sell.

The recommendations are based on 12 month horizon, unless otherwise specified. The investment ratings are on absolute positive/negative return basis. It is possible that due to volatile price fluctuation in the near to medium term, there could be a temporary mismatch to rating. * For reasons of valuations/return/lack of clarity/event we may revisit rating at appropriate time. Please note that the stock always carries the risk of being upgraded to BUY or downgraded to a HOLD, REDUCE or SELL.

Geojit Financial Services Limited has outsourced the preparation of this research report to DION Global Solutions Limited whose relevant disclosures are

available hereunder. However, Geojit’s research desk has reviewed this report for any untrue statement of material fact or any false or misleading

information.

General Disclosures and Disclaimers

CERTIFICATION

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REGULATORY DISCLOSURES:

Geojit Financial Services Ltd. (formerly known as Geojit BNP Paribas Financial Services Ltd.), Registered Office: 34/659-P, Civil Line Road, Padivattom, Kochi-682024, Kerala, India. Phone: +91 484-2901000, Fax: +91 484-2979695, Website: geojit.com. For investor queries: [email protected], For grievances: [email protected], For compliance officer: [email protected].

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