City Gas Distribution Giants Face Pressure Amid Profitability Concerns

The city gas distribution sector in India is currently experiencing a period of heightened activity, albeit for concerning reasons. Shares of Indraprastha Gas Ltd. (IGL), Mahanagar Gas Ltd. (MGL), and Gujarat Gas Ltd. have witnessed a significant drop following a 20% reduction in their gas allocation through the Administered Price Mechanism (APM). This governmental decision has set off alarms regarding potential impacts on the profitability of these companies.

The implications of this change could be considerable, as natural gas serves as a critical raw material for these firms. The recent cut necessitates that these companies import the remaining 50% of their gas requirements, likely at prices 50-60% higher than those for domestic gas. This scenario presents the companies with a difficult choice: either absorb a hit to their margins, which would affect profits, or increase Compressed Natural Gas (CNG) prices, potentially impacting sales volumes.

Analytical projections suggest that in order to preserve existing profit margins, these companies may need to implement a Rs 6 price increase in the CNG segment. Without such an adjustment, earnings could decline substantially—by 32% for IGL, 20% for MGL, and 24% for Gujarat Gas. However, the option of a price hike is further complicated by the timing of upcoming assembly elections, which may limit the feasibility of such measures.

Jefferies, a global brokerage firm, has pointed out that the government has reallocated 12-15% of APM gas previously assigned to city gas distribution companies. To cover this deficit, these companies might have to turn to spot or short-term LNG purchases, which could reduce EBITDA margins by ₹3 per standard cubic meter (scm) for IGL, ₹3 for MGL, and ₹2.3 for Gujarat Gas.

With an increasing reliance on market-linked gas reaching a threshold of 50%, these firms might be compelled to focus on maintaining margins rather than boosting volume growth, potentially leading to a derating of the sector, according to Jefferies. The brokerage indicated plans to reassess its estimates following any pricing adjustments by these companies in the coming days.

As of the latest market figures, shares of IGL have tumbled 12.09% to trade at ₹443.55. Mahanagar Gas shares have decreased by 12.70%, currently priced at ₹1,538.30, while Gujarat Gas shares are down 4.07%, trading at ₹547.05.

Investors and market watchers are advised to approach this evolving situation with caution. Analysts emphasize the importance of consulting with certified experts before making any investment decisions in light of the recent developments in the city gas distribution sector.