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Spark Capital: Gujarat Gas 3QCY12 Results Review: Strong Quarter; Maintain bearish view on margin risks




Spark Capital Advisors(India) Private Limited


05 Nov 2012





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Strong Quarter; Maintain bearish view on margin risks Gujarat Gas (GGAS) reported better than expected operational results with EBITDA (12% higher than est) up 17% yoy and 65% qoq as price hikes were followed by declining input prices. Lower spot LNG price qoq led to a flat gas cost of ~Rs. 22/scm, despite a 2% increase in fx and 2% volume growth. Realisation increased 6% qoq to Rs. 28.1/scm on the back of ~9% price hike undertaken in the Industrial segment (Jul’12). Hence, gross spreads widened by 34% qoq to Rs. 6.1/scm. Other income of Rs. 193mn grew by 135% qoq, due to a Rs. 90mn one-time reversal of provisions. Overall, earnings surged by 91% qoq (over a low base) and 24% yoy to Rs. 995mn. While margins were higher than expected, volumes of 3.2mmscmd (up 2% qoq) were tepid in a seasonally strong 3Q. Incorporating the quarter’s beat, we reduce our volume estimates and increase our spreads leading to ~8% upgrade in CY12 EPS. We see high risks to our CY13 earnings as price cut and volume growth could be higher than penciled in. Our mid-long term DCF estimates remains largely unchanged. Maintain bearish views on the stock with Reduce rating and TP of Rs. 288 Open offer Arbitrage: Assuming a post offer price of Rs. 288, there is an arbitrage opportunity of ~2.9% at 74.5% acceptance ratio. There would be no arbitrage if the acceptance ratio falls to 42% Price cut ahead: We believe these spreads are not sustainable especially when state owned entity is going to own the asset. While we strongly expect downward revision of prices post acquisition by GSPC, good part of 4Q would be behind us leading to another strong quarter. Next year could begin with the same Rs. 4-4.5/scm spread (Rs. 6.1 in this quarter) Business Strategy: GGAS’ strategy has always been value focused and at times even sacrificing volumes for better margins, whereas GSPC on the other hand is more focused on volume growth rather than margin. We believe GGAS is likely to undergo a DNA change under the hands of the new parent – “GSPC” and pursue a volume focused strategy. We see serious downside to spreads as GSPC could replicate the same high growth-modest margin model of GSPC Gas in GGAS. Further, It would surely pass on the benefit of falling input prices to consumers as seen in the case of GSPC Gas (extant CGD subsidiary of GSPC). Nevertheless, GGAS could get cheaper RLNG supply from GSPC’s portfolio of spot RLNG. At current valuations, we recommend investors to exit GGAS as we see further de-rating in the stock.

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