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Gujarat Gas: Visit note
Sep 14, 2005

Earlier this week, we met with the management of Gujarat Gas in Ahmedabad to understand the growth prospects of the company over the next three years, the unfolding of the natural gas regulatory regime and the competitive landscape.

What is the company’s business?
Gujarat Gas Company, a 65% subsidiary of the global gas major British Gas, is the country’s largest private sector gas distribution and transmission company and has a regional presence across three of the largest industrial cities in the state of Gujarat. With a pipeline network of around 2,000 kms (nearly 34% of GAIL’s gas pipeline network), the company caters to the textile, steel, pharma and diamond industries among others in the cities of Surat, Ankleshwar and Bharuch.

Apart from distribution, the company also transmits gas for other players (GSPCL) through its pipeline capacity. Transmission volumes stood at 808 MMSCM in FY05. However, with GSPCL already in advanced stages of completion of its own pipeline, Gujarat Gas stands at the risk of losing transmission revenues in the medium-term (contributed to 9.4% of gross sales in FY05).

The supply side scenario…
Total natural gas volumes in FY05 (December year ending company) touched 2 mmscmd (million standard cubic meters), which is among the highest in the gas distribution segment in India. Almost 93% of natural gas purchased by the company is market related. Compared to the likes of Indraprastha Gas, which only sources gas at administered prices (at subsidized rate), the fact that a significant proportion of gas purchased is based on international prices, places the company in a competitive position. New gas supply is expected to increase in the state of Gujarat primarily from three sources in the medium-term i.e. Petronet LNG expansion in Dahej, Shell LNG and Panna-Mukta oil fields. As far as the supply situation is concerned, unlike in the past, the company expects a favorable environment going forward.

Tax structure…
Sales tax on gas has gradually reduced over a period of time from as high as 20% plus 10% surcharge to 12% currently. Compared to petroleum products that attract a sales tax of 4%, the company believes that the sales tax on gas should also be reduced to make it more competitive. Given the fact that natural gas is cost-efficient and does not have pollution related issues, we expect sales tax to reduce over the long-term. However, the timing cannot be predicted.

CNG and retail – Key growth drivers…
Currently, the company has a total PNG (piped natural gas, an alternative to LPG cylinders) consumer base of 160,000 and is growing at 15,000 to 20,000 per annum. The company expects this rate of growth to continue in the next three years.

While medium-size industrial consumer base stands at 20,000 to 22,000, the large consumers are just 3. However, the large consumers account for 30% of sales. On the CNG side, the total number of vehicles currently addressed by the company is at 18,000. The company expects significant growth in CNG sales over the next three years. As compared to the current contribution of 2.5% of sales, it is expected to touch 10% in this period, in line with the implementation of the Gujarat Motor Vehicle Regulation Act.

As far as realisations are concerned, in FY05 it was Rs 9 per SCM (standard cubic meters), which is substantially lower than IGL (Rs 16 per SCM). This is because of two reasons. One, IGL has a relatively strong presence in the CNG segment where realisations are high, whereas this is not the case with Gujarat Gas. To put things in perspective, the total number of vehicle serviced by IGL in NCR region is over 94,200 vehicles i.e. 5.2 times higher than Gujarat Gas. But we expect average realisation to improve, especially given the impetus on the CNG side in the next three years. Secondly, the company’s assets are largely depreciated and the interest cost is minimal, which allows Gujarat Gas to price it at cheaper rates. For instance, IGL’s piped natural gas price is fixed at a 10% discount to LPG, whereas in the case of Gujarat Gas it is around 40%.

GSPCL transmission to impact performance…
Currently, GSPCL uses the pipeline of Gujarat Gas for its transmission purpose for which it pays around Rs 0.7 per SCM. From as low as 0.6% of revenues in FY01, the contribution from transmission revenues has increased to 9.4% in FY05. But with GSPCL already in the final stages of completion of its own pipeline, Gujarat Gas stands to lose this revenue stream going forward, in the worst-case scenario. However, the company hopes to mitigate this by working along with GSPCL for future gas supplies, which is likely to increase. In our view, until clarity emerges, we would take a conservative stance and reduce revenues from transmission to zero.

Regulatory environment…
The company believes that the de-regulation in the natural gas sector should be in the phased manner for it to be a profitable business for investors.
  1. It believes that the government should allow monopoly status to players, irrespective of public or private for a certain number of years (say 15 to 20 years), as cash flows are expected to be strong only after the first eight years or so.

  2. In the second phase, like in the telecom sector, allow multiple players by implementing a license fee or revenue share regime.

The company also believes that like distribution, transmission should also be freed, in the sense that existing transmission players like GAIL should allow others to utilise the pipeline for gas distribution in other cities (like Gujarat Gas’ agreement with GSPCL). This, it believes, will provide a big kicker to gas distribution in the long-term. The Natural Gas Regulatory Bill 2004 is being formed in this regard.

Expansion plans…
As compared to 2 CNG stations two years back, Gujarat Gas has 7 CNG stations in Surat in FY05, which is expected to increase by 5 to 6 in this fiscal year. Besides the current presence, the company hopes to expand presence in Vapi (a very strong industrial belt) by mid next year.

Power sector – Promising prospects…
The company is aggressively focusing on the power sector (like its parent company and its operations worldwide). Currently, under the CHP segment (Combined Heat & Power), there is already 130 MW of capacity running on CHP programme for which Gujarat Gas supplies gas (0.75 scmd). The CHP is a programme wherein the company would work with a small customer who is interest in saving power cost by setting up around 1 MW plant.

But as we go forward, the company hopes to work with 2 to 3 large players in setting up power plants, in which Gujarat Gas would hold a stake through a SPV (special purpose vehicle). The role of the company will be restricted to only being the preferred gas supplier and not with the management of the capacity. This, we believe, is a very big positive and is expected to be a major growth driver.

Others…
As far as GSFCL (finance arm of Gujarat Gas to assist customers migrate to gas) and GTCL (transmission company that provide customer the sales tax benefit) are concerned, while the lack of scale is an issue with the financing arm, the transmission subsidiary is likely to be affected with GSPCL completing its own pipeline. But the company is looking at either exiting from the financing arm or restructuring it. The transmission arm may be used as the SPV for power projects.

Two things to watch out for…
  1. CHP and application development. Application development here refers to meeting the energy requirements of various players for varied purposes like diamond cutting and powering air conditioning for malls, theatres and commercial premises. Gas can be used to power air conditioners that have capacity of more than 30 to 50 tonnes.

  2. Availability of gas, which is expected to improve significantly going forward. The company may look at replicating its experience in Gujarat to other states as well. However, it depends on the regulatory environment and is unlikely to take material shape in the next three years.

What is our view?
We are very enthused by the company’s growth plans over the next three years. We are currently in the process of updating the report. But looking at valuations, we would like to exercise caution at current levels.

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