Nomura Downgrades IGL And MGL, Maintains Bearish Stance On Indian Oil And Gas Sector

Nomura Research has downgraded Indraprastha Gas Ltd. to 'Reduce' and reiterated its 'Reduce' on Mahanagar Gas Ltd., lowering their target prices and maintaining a bearish stance on the country’s city gas distribution (CGD) companies. This downgrade comes on the back of recent developments in the sector, including a second round of cuts to the 'Administered Price Mechanism' gas allocation, which are expected to weigh heavily on margins and future growth prospects for both companies.

In its report Nomura noted that IGL has seen its APM gas allocation cut by another 20%, while MGL faces a reduction of 18%, following a similar cut of approximately 20% in October 2024.

The latest cuts come as a significant blow to the CGDs, which rely on APM gas, priced at $6.5 per MMBtu, for a substantial portion of their sales, especially in the 'Compressed Natural Gas' segment. With the CNG volumes now at risk, IGL’s allocation stands at just 37%, while MGL’s share has fallen to 39%, both of which are expected to further erode profitability.

Nomura highlighted that the reduction in APM gas availability will force the CGDs to turn to alternative sources of gas, such as 'High Pressure High Temperature' gas, new well gas, 'Brent-linked gas', and 'spot LNG'. These alternatives are significantly more expensive, with prices ranging from $8.5 to $13.6 per MMBtu, which is up to 2.1 times higher than the APM price. The resulting cost pressures will likely translate into higher CNG prices, which are essential for maintaining profitability.

As IGL and MGL face a double whammy of reduced allocations and higher input costs, the companies will likely struggle to maintain margins without passing on the cost increases to consumers. Nomura estimates that IGL will need to increase its CNG prices by around Rs 8-9 per kg, while MGL will need to hike prices by Rs 9-10 per kg to cover the higher costs.

However, the firms will face challenges in implementing price hikes, with political sensitivities playing a role. MGL, operating in Maharashtra, could see price hikes sooner after the state elections, whereas IGL, operating in Delhi, will likely have to delay price increases until after the Delhi elections in February 2025.

The slowdown in CNG vehicle adoption and rising competition from alternate fuels further complicate matters. Nomura pointed out that the economic advantage of CNG over traditional fuels like gasoline and diesel will shrink if the price hikes materialise, potentially affecting volume growth. In cities like Delhi and Mumbai, where CNG enjoys a significant cost advantage over other fuels, the price increases could reduce the attractiveness of CNG, slowing down the shift to cleaner fuels.

In light of these headwinds, Nomura has revised its target price for IGL down to Rs 340 from Rs 370 and has reiterated its 'Reduce' rating on MGL, lowering its target price to Rs 1,130 from Rs 1,250. Nomura’s analysts remain cautious on the Indian oil and gas sector, which faces significant challenges from rising gas prices, slowing CNG demand, and potential regulatory changes.

On Tuesday, Indraprastha Gas share price fell as much as 2.6% to hit Rs 316.74, its lowest level since March 25, 2020, before paring losses to trade 0.5% lower at Rs 323.50 at 9:43 a.m.

Out of the 36 analysts tracking the company, 15 maintain a 'buy' rating, eight recommend a 'hold,' and 13 suggest 'sell,' according to Bloomberg data. The average 12-month consensus price target implies an upside of 36.6%.

Mahanagar Gas' stock fell for the seventh consecutive session, losing more than 22% in the fall. At 9:47 a.m., it was trading 1% lower at Rs 1,118.85.

Fourteen analysts have a 'buy' on the stock, seven recommend 'hold' and 12 suggest 'sell'. The average 12-month consensus price target implies an upside of 39.2%