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Comparison of three oil and gas midcaps
Oct 20, 2008

When the stock markets start tumbling, it is a good time to bring out the shopping bags and go bargain hunting. The first name that comes to mind while looking for bargains is Benjamin Graham. In this article, we shall look at the relative merits of three oil and gas midcaps – Indraprastha Gas (IGL), Gujarat Gas and Castrol- using two tests inspired by Mr. Graham. Test 1: PE multiple
In this test we calculate the multiple of the current share price to the company’s average earnings per share (EPS) over the past 5 years. Taking past earnings is a conservative measure of the company’s earning potential, as it doesn’t take future growth potential into account. Taking the last 5 years ensures that at least one business cycle is taken into account. We also note the average operating margins (OPM) and net profit margins (NPM) of the companies over the past 5 years.

Company OPM NPM Price EPS* P/E
IGL 41% 22% 103 8 12
Gujarat Gas 19% 11% 222 15 15
Castrol 16% 10% 309 13 24

Test 2: Embedded debt
This test is another way of testing the reasonableness of the stock price. It is based on the principle that the value of a debt free company has to be substantially more than the amount of debt it can comfortably service. In this test, we take the earnings before interest and taking an interest cover of 3 times, derive the interest the company can bear, i.e., EBIT/3. Having found the interest it can bear, we calculate back the debt the company can bear by using the rate at which banks would lend to an established company, i.e., prime-lending rate of 11.75%. The amount of debt that the company can comfortably hold is calculated as interest/11.75%.

Company EBIT* (Rs m) Interest Debt Price Shares (m) Market cap Capacity
IGL 2,609 870 7,401 103 140 14,434 51%
Gujarat Gas 2303 768 6,535 222 64 14,229 46%
Castrol 3,436 1,145 9,748 309 124 38,205 26%
*CY07 for Gujarat Gas & Castrol, FY08 for IGL

According the above calculations, IGL can service a debt to the extent of 51% of its current market capitalisation, while Gujarat Gas can manage 46% and Castrol only 26%.

Conclusion
We can conclude from the above tests that Indraprastha Gas appears to be the best among the three companies in terms of stock selection. It has the best margins, is selling for the lowest PE multiple and has the best debt-servicing capacity. It may be noted that we have focused solely on the numbers and have not factored in the relative qualitative positions of the companies.

  • Also read - Indraprastha Gas: How low can it go?

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