By Geetanjali Kedia

Mahanagar Gas Limited is entering the primary market on Tuesday 21^st June 2016, with an offer for sale of upto 2.47 crore equity shares of Rs. 10 each, by promoters, in the price band of Rs. 380 to Rs. 421 per share, with an employee discount of Rs. 38 per share (no retail discount). Issue, representing 25% of the post issue paid-up capital, will raise Rs. 938 crore and Rs. 1,040 crore at the lower and upper price band respectively (all secondary money) and will close on Thursday 23^rd June.

Mahanagar Gas, a city gas distribution company, is an equal joint venture between GAIL and British Gas (now owned by Royal Dutch Shell), each owning 45%, with balance 10% held by Maharashtra State Govt. Company supplies compressed natural gas (CNG) to 4.7 lakh vehicles, through 188 CNG filling stations and distributes piped natural gas (PNG) to 8.6 lakh households and 2,900 commercial establishments in Mumbai and its adjoining areas. It has recently been awarded distributorship for Raigad district in Maharashtra. For FY16, company sold 2.43 mmscmd gas, split 74:26 between CNG and PNG by volume, and 71: 29 by turnover.

Despite operating in Mumbai for nearly 20 years, its coverage is quite low. Of Mumbai’s 27.1 lakh households, as per 2011 census, it caters to only 8.6 lakh households (as at 31 March 2016) - barely 32% of market size. Increased households over 2011-16 will only lower this penetration number. No wonder company’s growth has been slow. Market size is huge, given the untapped potential in Mumbai itself, where majority of the distribution infrastructure is already in place, in addition to the new market of Raigad.

While company’s topline grew at a CAGR of 12% between FY12 to FY16, from Rs. 1,309 crore to Rs. 2,079 crore (on volume CAGR of 6%), net profit growth was missing, as net profit remained stagnant from Rs. 307.7 crore in FY12 to Rs. 308.7 crore in FY16. EBITDA growth was also paltry at CAGR of 1.8% during FY12-16 (FY16 EBITDA Rs. 556 crore versus FY12 EBITDA of Rs. 518 crore), as company is unable to pass on higher input costs to customers. Cost of inputs, accounting for 47% of sales in FY12, shot up to 59% in FY16, which proportionately dented EBITDA margin - slipping from 40% in FY12 to 27% in FY16. Low growth in profitability also resulted in Return on Equity (RoE) declining from 29% in FY12 to 20% in FY16.

Of FY16’s PBT of Rs. 467 crore, Rs. 30 crore was earned on account of treasury operations on surplus cash, which implies about 6% of profits from non-core activities. Corollary, only 5-7% p.a. return is generated on liquid investments, which is quite low. Returns of 10%-12% p.a., with better treasury management, is warranted, to make the idle cash sweat prudently!

As of 31st March 2016, equity stood at Rs. 89.34 crore, which currently stands at Rs. 98.78 crore, on account of conversion of CCDs by Maharashtra Govt. on 7th June 2016. Net worth, as of 31-3-16, stood at Rs. 1,528 crore, of which, Rs. 560 crore is cash and equivalents, while company has sundry debt of Rs. 4 crore. Thus, it is a debt free company with surplus cash of Rs. 56 per share. While company is yet to declare dividend for FY16, for FY13, FY14 and FY15, it paid dividend of Rs. 17.50 per share, which indicates an attractive dividend yield of 4.2%.

Majority of the gas (entire CNG requirement and PNG for households, which accounts for ~85% of volume sold) is sourced under the administered price mechanism from the Govt., at concessional rate, currently at US$ 3.06 per mmbtu. Quantity of 110% of last 6 month’s consumption is available to the company under this mechanism, for distribution as CNG and PNG to households. Hence, in some sense, sales volumes for the company is capped i.e. it cannot shoot up drastically in a short span of time. This remains a drawback. 

At upper end of price band of Rs. 421, company’s market cap will be Rs. 4,160 crore and enterprise value (EV) Rs. 3,600 crore. The historic EV/EBITDA multiple, on FY16 EBITDA of Rs. 556 crore, is 6.5 times, while historic PE multiple, on PAT of Rs. 309 crore, is 13.5x. Estimating FY17 EBITDA of Rs. 575 crore leads to EV/EBITDA multiple of 6.3x and PE multiple of 13x, based on the current year estimated earnings.

Despite poor growth and drop in margins, on a peer comparison, company’s margins are very healthy, as depicted in the peer comparison table below:

Mahanagar is the 3^rd largest city gas distribution company in India, trailing Gujarat Gas and Indraprastha Gas, operating in Gujarat and Delhi/NCR respectively. Although it is nearly half the size of its peers, both its EBITDA margin and net margin are much higher, even in relation to Indraprastha Gas, which draws nearly 80-85% sales from CNG and domestic PNG, similar to Mahanagar. Gujarat Gas focusses more on the commercial and institutional segment. On valuation front too, Mahanagar scores over both its peers, on all counts – EV/EBITDA and PE multiple, EBITDA per scm and EV per scm. Hence, issue pricing is attractive.

Despite stagnant financial performance, company’s margins remain healthy vis-à-vis peers. Attractive pricing coupled with bright industry prospects make this issue a buy. One can apply at the upper band for both listing gains and with a medium term view.

Disclosure: No interest.