IGL, Mahanagar Gas Shares Plunge up to 15%: Government Cuts Priority Gas Allocation

Shares of major city gas distribution companies, including Indraprastha Gas Ltd (IGL) and Mahanagar Gas Ltd (MGL), faced significant declines on Friday, October 18, 2024, following the government’s announcement of a sharp reduction in priority gas allocation. The stocks of these companies nosedived by up to 15%, with MGL falling 14.66% and IGL dropping 12.92%, raising concerns among investors about the future profitability of these firms.

MGL’s stock hit an intraday low of ₹1,503.75, while IGL shares slumped to ₹439.35 on the National Stock Exchange (NSE). The decline in share prices followed the news that the government had reduced the allocation of domestically produced Administered Price Mechanism (APM) natural gas, which is crucial for city gas distribution companies (CGDs) like IGL and MGL.

What Led to the Sharp Drop?

The sell-off was triggered by a policy update from the Ministry of Petroleum and Natural Gas, which announced a reduction in the allocation of APM gas to CGD companies. APM gas is priced at a government-set rate, making it cheaper than imported gas. The gas is primarily allocated for priority segments such as Domestic Piped Natural Gas (PNG) and Compressed Natural Gas (CNG) for transportation.

According to the new policy, gas allocation will be limited to the quantity available for priority sectors and distributed by GAIL (India) Limited. This reduction, effective from October 16, 2024, slashes the gas supply for these companies by approximately 20-21%, which is expected to negatively impact their margins and profitability.

MGL stated in its stock exchange filing that the reduction in CNG (transport) gas allocation will adversely affect its financial performance. To bridge the gap, the company is exploring alternative sources of gas, including domestically produced High-Pressure High Temperature (HPHT) gas, New Well/Well Intervention gas (NWG) from ONGC, and benchmark-linked long-term contracts.

Impact on Profit Margins and Consumer Prices

The reduction in domestic gas allocation is expected to have a significant impact on CGD companies’ profitability. Natural gas is a key raw material for these firms, and the shortfall in domestic supply will likely force them to rely on more expensive imported gas. Analysts warn that this shift could lead to a surge in operational costs, which could either be passed on to consumers in the form of higher prices or absorbed by the companies, further squeezing their margins.

Jefferies, a global brokerage firm, noted that the reallocation of 12-15% of APM gas would require CGD companies to increasingly depend on short-term Liquefied Natural Gas (LNG) imports. The firm estimates that EBITDA margins for IGL, MGL, and Gujarat Gas will be reduced by ₹3 per Standard Cubic Meter (SCM) for IGL, ₹3 for MGL, and ₹2.3 for Gujarat Gas.

Possible Price Hikes in CNG

To maintain profit margins, companies like IGL and MGL may need to increase CNG prices by ₹6 per kilogram, analysts suggest. However, any substantial price hikes could negatively impact sales volumes, as consumers might opt for alternative fuel sources. This creates a challenging situation for these companies, especially with upcoming assembly elections in Maharashtra, where price hikes could be politically sensitive.

JM Financial analysts estimate that the potential CNG price hike could range between ₹3.5 and ₹5 per kilogram, which would represent a 5-7% increase. Such price increases could undermine the companies’ pricing power in the CNG market, posing risks to both volume growth and margins.

Analysts Downgrade IGL and MGL Stocks

In light of these developments, several brokerage firms have downgraded their ratings for IGL and MGL. JM Financial has downgraded both companies to a ‘sell’ rating, with revised target prices of ₹435 for IGL and ₹1,400 for MGL. The firm estimates that earnings for IGL could fall by as much as 32%, while MGL might see a 20% decline. Gujarat Gas, another major player in the city gas distribution sector, is expected to experience a 24% drop in profitability.

This situation could lead to a derating of the CGD sector, as companies face growing uncertainties about future government policies, especially regarding gas allocations and pricing mechanisms. The increased reliance on expensive imported gas and the potential for reduced sales volumes could significantly alter the growth outlook for the sector.

Outlook for the City Gas Sector

The city gas distribution sector in India has been an attractive investment option due to its strong growth potential and favorable regulatory environment. However, the recent reduction in APM gas allocation has raised concerns about the sector’s future profitability and growth prospects. With CGD companies now facing higher operational costs and the possibility of political pushback on price hikes, the sector’s long-term growth trajectory remains uncertain.

Global brokerage Jefferies has stated that CGD companies may have to prioritize maintaining margins over volume growth, which could hurt their market position. In addition, any further cuts in gas allocations or changes in government policy could exacerbate the challenges faced by these companies.

While CGD companies are exploring alternative gas sources and strategies to mitigate the impact of the allocation cut, the short-term outlook for the sector appears bleak. Investors and analysts alike will be closely watching how these companies navigate the current landscape and whether they can maintain profitability in the face of rising costs.

A Challenging Road Ahead for CGD Companies

The sharp decline in shares of IGL and MGL reflects the market’s concerns about the future of the city gas distribution sector in India. The reduction in priority gas allocation is likely to have a lasting impact on profitability, and companies will need to carefully balance the need for price hikes with the potential for reduced sales volumes.

As CGD companies face higher operational costs and potential political pressures, their ability to maintain profit margins while navigating a challenging regulatory environment will be critical to their long-term success. Investors should remain cautious as the situation unfolds, with further developments in government policy likely to influence the sector’s prospects.