|Date of report||November 13, 2017|
|Target Price (Rs)||394|
Restrictions On Pollution-generating Fuels To Boost Gas Demand
We initiate coverage on Indraprastha Gas (IGL) with Buy rating and FY20E earnings-based target price of Rs394. Our bullish call is based on earnings growth because of: 1) Growth in sales volume on strong government support for making a shift to natural gas as a preferred fuel. 2) Recent favourable judgement from the Supreme Court banning some alternate fuels because of environmental concerns. 3) Monopoly situation with high entry barriers. 4) Strong balance sheet with a net cash position. 5) Strong free cash flow to the firm, despite rising capex. 6) RoE of 19% and RoCE of +30% likely over FY18E-FY20E.
Strategy focused on NCR, geographical expansion to drive volume-led growth: IGL is focused on developing and maintaining infrastructure in NCR and adjoining areas to increase natural gas usage for energy needs. High barriers to entry and lack of competition in focus areas together with strong government support will drive growth.
Government’s plan to increase natural gas usage; environmental concerns to drive conversion to CNG, PNG: The government has repeatedly indicated its intention to shift to natural gas as a preferred fuel for energy. To improve growth in compressed natural gas or CNG and piped natural gas or PNG (residential), government supplies natural gas at a competitive rate to make it cheaper relative to other
3 year earnings CAGR (FY17-20E) of 15% based on volume growth at CAGR of 14%: We expect the earnings growth of 15% during F17-20E based on the expected sales volume growth of 14%. The key driver for the earnings growth is expected to be volume since the company expects to be maintain EBITDA/scm within a range.
Strong balance sheet despite capex for sustained growth gives comfort: Despite high capex to improve the infrastructure network for CNG and PNG, the company has a debt-free balance sheet. Capex for the past five years has been met consistently from internal accruals.
Strong operational cash flow supported by negative working capital: IGL has consistently shown a healthy positive operational cash flow which has provided for the annual capex and a consistent positive free cash flow. Consequently, IGL has been able to pay of it’s debt. The capex is expected to rise to Rs6bn from FY18, but we believe the company will be able to meet the requirement from internal accruals. The company has consistently maintained negative working capital because of high payables relative to inventory and recievables.
Strong free cash flow despite rise in capex, likely over FY18E-FY20E: With a rise in capex, we expect free cash flow to decline over FY18E-FY20E. We expect free cash flow to remain firm at Rs2bn in FY18E, but rise to Rs5bn in FY20E.
RoE and RoCE expected to remain at approximately 19% and +30%, respectively: We expect RoE and RoCE for FY18E-20E to remain at around 19% and +30%%. RoCE is higher relative to RoE as the company has net cash which reduces the capital employed compared to equity.
Recommend Buy rating on IGL with a target price of Rs394: Our valuation of IGL is based on 30xFY20E earnings. Despite FY18E-FY20E earnings CAGR of 15%, we have valued the stock at 30x FY20E earnings because of: 1) Strong probability of higher-than-expected earnings growth following the recent Supreme Court announcement banning the usage of pet coke and furnace oil. 2) Strong balance sheet with net cash position. 3) Strong operational cash flow together with negative working capital which is expected to provide for future capex. 4) Strong monopolistic situation in NCR region ensuring earnings visibility. 5) Government’s focus on growth in natural gas as the preferred mode for meeting energy needs will aid in driving sales. 6) Rising environmental concerns in NCR have added to strong focus of the government on pushing natural gas as the preferred energy provider.