City Gas Distribution Sector Faces Major Turmoil

Shares of Indraprastha Gas Limited (IGL) and Mahanagar Gas Limited (MGL) plummeted 20% in early trading on November 18, 2024, following a government decision to further reduce gas allocation under the Administered Price Mechanism (APM) by 20% for the second consecutive month. Gujarat Gas also saw a dip of 5.8% in its stock price.

This decision has exacerbated challenges for city gas distribution (CGD) companies, which rely heavily on cheap domestic gas for compressed natural gas (CNG) production and piped cooking gas distribution.

Government’s Role in Gas Allocation Cuts

The cuts in APM gas allocation have impacted CGD companies’ ability to meet demand efficiently.

• October 2024: Domestic gas supplies were reduced by 21%.
• November 2024: A further 20% cut was announced, starting November 16.

The reduction in allocation leaves CGD companies increasingly dependent on imported liquefied natural gas (LNG), which is significantly more expensive, nearly twice the price of domestic gas.

Impact on CGD Players

1. Indraprastha Gas Limited (IGL)
   • Stock fell 20% to ₹324.7 on the NSE.
   • Domestic allocation cut by 20% for the second consecutive month.
   • Profitability outlook dims as input costs rise and reliance on costlier LNG increases.
   • Brokerage Actions:
     • Jefferies downgraded IGL to "underperform," cutting its target price to ₹295.
     • Nuvama Institutional Equities highlighted potential 43% EBITDA decline by FY26 if gas prices remain elevated.

2. Mahanagar Gas Limited (MGL)
   • Shares dropped 12% to ₹1,150.75.
   • Domestic gas supply reduced by 18% after the previous 21% cut.
   • Brokerage Actions:
     • Downgraded by Emkay Global and Jefferies with reduced target prices of ₹1,130.

3. Gujarat Gas
   • Shares fell 5.8% to ₹458.
   • Lesser cuts compared to IGL and MGL but still faces profitability challenges.
   • Brokerage Actions: Maintained a "hold" rating due to moderate exposure to domestic allocation cuts.

Key Challenges for the Sector

1. Reliance on Expensive LNG
   The reduced allocation of cheap domestic gas has forced CGD players to substitute with imported LNG, priced at $13–14 per MMBtu, compared to domestic gas priced at $6.5 per MMBtu.

   • This substitution may result in blended EBITDA margins falling by ₹2.7–3 per SCM.

2. Potential CNG Price Hikes

   • Analysts project that CNG prices could rise by ₹4–6 per kg if costlier LNG continues to bridge the shortfall.
   • Retailers are holding off on price increases, awaiting a resolution from the Ministry of Petroleum and Natural Gas.

3. Declining Domestic Gas Production

   • Production from legacy fields, which supply domestic gas, is declining by 5% annually due to natural depletion.

Brokerage Reactions and Sector Outlook

• Jefferies: Downgraded IGL and MGL to "underperform" and revised EPS estimates downward for FY26, citing diminishing profitability.
• Emkay Global: Warned of deteriorating margins and noted no immediate clarity on mitigation strategies.
• Nuvama Institutional Equities: Expressed concerns over profitability erosion, projecting a 63% decline in EBITDA for some CGD companies by FY26.

Conclusion

The CGD sector faces a challenging road ahead with sharp reductions in APM gas allocation and rising reliance on imported LNG. While this may lead to price hikes for CNG, consumers and companies alike are bracing for higher costs. Analysts recommend cautious investments in the sector, with many downgrading stocks like IGL and MGL amid uncertain policy outlooks.

Investors and stakeholders should monitor developments closely, particularly regarding policy changes and pricing strategies, to navigate this volatile phase effectively.