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Gas sector - CGD: Competition to hit margins, volumes and lead to derating - ICICI Securities

Posted On: 2020-11-27 01:09:13 (Time Zone: Arizona, USA)

With PNGRB notifying access code and determination of transportation rate for CGD regulations, the decks are now cleared for competition in CGD areas where marketing exclusivity is over. PNGRB is now likely to allow competition in these CGD areas one by one. Incumbents may take the matter to Delhi High Court (HC), which may at best delay the advent of competition. OMCs, which are likely to emerge as the main competitors, have fired the first salvo by asking for 90-100% rise in their commission w.e.f. FY19. Regulations not allowing OMCs to terminate agreement with incumbents to install their own CNG dispensers is not as big a positive for incumbents as some believe; it would have meant plunge in volumes, which neither the stock nor any investor was pricing-in. Regulations appear to require OMCs to install CNG dispensers only in stations where incumbents do not have a presence. This may mean competition hits incumbents' volumes and margins gradually, but a downward trend appears imminent. We reiterate SELL / REDUCE on IGL / MGL, and BUY on GGL (least impacted by competition).

- Any challenge in court to competition being allowed unlikely to succeed: CGD players may challenge competition being allowed in Delhi HC as it had in Sep'15 ruled that any order by PNGRB allowing competition would be subject to further order by it. PNGRB is confident that its regulations would pass muster with Delhi HC. CGD players boosting EBITDA margin by not passing on the full benefit of fall in domestic gas price and PNGRB not allowing OMCs to take over incumbent's existing CNG stations on their site would hurt their case in Court. GoI had in Feb'14 directed CGD players to fully pass on the benefit of fall in gas costs and said it would stop supply of cheap domestic gas to CGD players who don't pass on the full benefit. Competition will make this provision implementable.

Domestic gas price down by Rs5.7/scm while CNG realisation of IGL down by only Rs2.6/scm and MGL's by just Rs2.3/scm since Q2FY20

- Key provisions of the regulations: At least 20% of the CGD network and compression capacity would have to be made available for open access to new entrants as per the regulations. PNGRB in the call with investors on 6-Jul'20 had stated that if spare capacity is more than 20% of network capacity, it may have to be offered for open access. As per our discussion with PNGRB, regulations do not allow OMCs to terminate agreement with incumbent and set up their own dispensers in CNG stations where incumbent had one as PNGRB wants new infrastructure creation. Whether OMCs can set up own dispensers while continuing to dispense CNG for incumbents is a grey area; PNGRB said "probably that may also not be allowed". Even if OMCs can install CNG dispensers only at stations where incumbents do not have a presence, it can only delay competition, which would eventually hit volume growth and margins of incumbents.

- OMCs likely to emerge as formidable competitors: The three OMCs are likely to emerge as formidable competitors in Mumbai, Delhi and Pune and hurt IGL and MGL. 60% of IGL's volumes and 60-65% of MGL's volumes are from CNG stations, which are on OMC sites. OMCs, who currently receive commission of Rs3.7-4.0/kg on CNG have demanded 90-100% rise in their commission retrospectively w.e.f. Apr'18. Thus, while incumbents would charge new entrants (likely to be OMCs) cost plus 12% return tariff for use of at least 20% of their transmission capacity, OMCs can charge incumbents high commission for use of their sites to dispense CNG.

Source: Equity Bulls

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