“So, pretty steep price hike that is required to sort of restore the margins to what they were, let us say, from an FY24 benchmark perspective,” says Probal Sen, ICICI Securities.

Firstly, this is the second cut that we have seen when it comes to the APM gas allocation. So, cumulatively, how much has been the APM gas allocation reduced for the city gas distribution companies? And to mitigate this impact, what is the kind of price hike that they need to take now?
Probal Sen: So, a couple of quarters ago, the blended allocation, as you would know the cut has primarily come in the CNG segment, so the domestic PNG segment still continues to get close to what is required to supply from what our understanding is. So, on a blended basis, this allocation was close to about 70%. It came down to just about 57% after the October cut. And assuming this 20% percent cut is again on that base, it means that the net blended allocation would be closer to about 38% to 40% now, so that is the cut. If we look at from a price increase perspective, the previous cut itself, assuming everything else remained the same would have entailed Rs 4.5 to Rs 6 per kg kind of increase in the CNG prices. This will add on another Rs 2.5 odd on top of that.

So, pretty steep price hike that is required to sort of restore the margins to what they were, let us say, from an FY24 benchmark perspective.

So, clearly, there is a conundrum now between either they want to increase their margins or they want to increase the volume. And how do you think city gas distribution companies might react to this? Whether they will take a price hike in a staggered manner or will they take a partial price hike and also try to keep the volumes on the higher side, how do you think the reaction would be?
Probal Sen: As you rightly mentioned, it is a conundrum in terms of how much of hike can be actually passed on without it actually hurting volume growth, so I think that is a decision that each company will have to take based on their assessment of what the differential is with the alternate fuels. The differential with alternate fuels like petrol and diesel is the highest in Mumbai and probably the lowest in IGL‘s case, because in Delhi the tax structure is slightly different for even petrol and diesel compared to Bombay.

So, to that extent, the leeway to increase or pass on the prices is probably the lowest and that sort of reflects in the way that the stocks have reacted. Having said that, over a period of time what should happen is that as alternate sources are also tapped and you basically figure out a way to actually mitigate this, you would probably gradually come to some sort of a balance in terms of what price hike you need to take because spot LNG prices are at a fairly large range at this point of time.

There are HPHT sources available as well. So, it will really be a function of how you can actually fill this shortfall that is now coming up, plus what the differential with alternate fuels is. But we do feel that over the next at least 6 to 12 months the margin profile will definitely trend downwards and then we will have to see what is the new normal as far as a sustainable margin environment is for all the three companies.

Now, given the fact that such a negative news has actually come in for the city gas distribution companies and these were some companies that used to earn a steady set of margins in the past. So, do you think there could be a shift of investments from CGDs to OMCs given the fact that crude has continued to remain below the $75 per barrel mark? GRMs are now averaging around the $6 per barrel mark. So, some kind of stable margin scenario that we are seeing at least for the oil marketing companies right now. So, do you expect some shift in investment also to happen?
Probal Sen: Well, I do not know if OMCs will ever have a stable margin environment. But yes, relatively speaking at this point of time, obviously there is a little bit of a lot more uncertainty around the margin trends of the CGD companies. To be fair, the reaction today itself and in the previous iteration when the cut was announced for the first time in the second fortnight of October, it does sort of factor in most of this hit.

But as of now, as an investment option, yes, OMCs probably look more favourable. Marketing margins are still at fairly high levels. GRMs have started to recover. So, to that extent, OMCs perhaps would be more better of a tactical buy. But I would still believe that particularly in view of the correction that has happened, as long as gradually this margins basically stabilise at a certain level, CGDs do still have a decent runway or growth over a slightly longer-term period.

Soumeet tells me that Gujarat Gas is the least impacted, but within IGL as well as MGL, if you had to pick up a better placed company, what will be the pecking order?
Probal Sen: I would continue to probably look at Gujarat Gas, MGL, and IGL in that order. As far as preference goes. As rightly mentioned Gujarat Gas obviously has in addition to being the least impacted by this move because in any case less than 22% of their volumes comes from CNG.

MGL, as I mentioned, because one, it anyways has been working on diversifying its sourcing portfolio over the last couple of years, it has inorganic growth opportunities through Unison that are going to add some scale and heft to the business.

Plus, as I said, the tax structure being what it is, as of now the differential with alternate fuels is probably the most advantageous for MGL relative to IGL. So, to that extent, at the margin I think that would be my preferred pecking order at this point of time.

But do you think the bulk of the correction is over now? The two kind of cuts that we have seen in the gas allocation because you do have that uncertainty looming as well. Could this be a de-rating trigger for the entire sector and cause a mass exodus of investors?
Probal Sen: I would believe that the business prospects still remain fairly attractive. Yes, it is a slightly harsher margin environment that one has to look at and therefore, the correction that has happened where stocks are down probably close to 20-25% in aggregate over the last month or so. So, to that extent, I would believe that a lot of the correction has already played out. Having said that, obviously, buying interest will take a little bit more time to come through as the situation probably becomes clear or the next couple of fortnights people will want to look at whether there are further cuts that are in prospect as far as this allocation is concerned. So, once I think that picture becomes clear, one can probably take a more clearer view of when the investment interest would return.