The current section of “Analysis” series covers Mahanagar Gas Ltd, the distributor of natural gas in the Mumbai and Thane region supplying piped natural gas (PNG) to homes and compressed natural gas (CNG) to automobiles.
“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.
In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.
Mahanagar Gas Ltd Research Report by Reader
Financial analysis of Mahanagar Gas Ltd:
A. Analysis of profit and loss statement:
1. Sales Growth:
Sales Growth of Mahanagar Gas Ltd for the last 10 years is 15% however if we analyze for last 3 yrs. this is just 2 %. This is because the price for natural gas has gone down from 2014 onwards. I have searched for the price trend online but I was not able to get this. While going through the annual report of 2017-18 and 2016-17 we can get some idea about the costs for Mahanagar Gas Ltd.
When dug further in the annual report, there is an increase in the daily volume of gas supplied by Mahanagar Gas Ltd from 2.43 MMSCMD in 2016 to 2.73 MMSCMD in 2018
Operating profit margin (OPM) of Mahanagar Gas Ltd for 2015 and 2016 is 23%. Major contributors for the costs are raw material cost and selling admin cost as compared to previous years. OPM is consistently in the range of 25-30%.
Net profit margin (NPM) is in range of 15 -25%.
The main disadvantage for this business is that the government decides the prices and Mahanagar Gas Ltd does not have a pricing power, neither from the suppliers nor from customers. However, still, Mahanagar Gas Ltd has maintained good NPM and OPM.
In the annual reports, Mahanagar Gas Ltd has mentioned about mitigating this risk by spot purchase of RLNG, which need further analysis for impact on costs.
Mahanagar Gas Ltd is paying taxes at a rate of 30% as per industry norm.
4. Interest coverage:
Mahanagar Gas Ltd is almost debt free. Hence, the operating profit is able to cater to the very small interest outgo. In case of bad outward economic conditions, Mahanagar Gas Ltd will still survive.
B. Balance sheet analysis of Mahanagar Gas Ltd:
1. Debt to Equity:
Debt to Equity ratio of Mahanagar Gas Ltd is almost zero, which is a good sign for the company. This industry is capex heavy and still, Mahanagar Gas Ltd has maintained zero debt.
2. Current Ratio:
The current ratio of the company for 2018 is 1.3 for 2017 it was 1.2.
Mahanagar Gas Ltd is able to pay its short-term liabilities with its current assets.
C. Cash Flow Statement of Mahanagar Gas Ltd:
Cash flow from operations of Mahanagar Gas Ltd has taken care of the complete investment requirements without any debt.
1. Cumulative Profit after tax and CFO:
Cumulative net profit after tax (CPAT) of Mahanagar Gas Ltd for last 10 years is ₹2,921 cr and the cumulative cash flow from operations (CFO) is ₹3,988 cr. It indicates a positive net cash flow.
Mahanagar Gas Ltd is able to generate a free cash flow (FCF) of ₹2,069 cr. Cash flow from operations is able to take care of the capex requirement.
Self Sustainable Growth Rate Analysis of Mahanagar Gas Limited
Self sustainable growth rate (SSGR) of Mahanagar Gas Ltd is more than its sales growth. The company is able to generate cash for its future growth.
Valuation analysis of Mahanagar Gas Ltd
- Price to earnings ratio (PE ratio) of Mahanagar Gas Ltd stands at 17.5, which is high. However, when compared to Indraprastha Gas Ltd, which is in a similar business to MGL and has a PE of 27.54, the PE ratio of Mahanagar Gas Ltd looks lower. The average PE ratio of this industry is 19.34.
- The price to book value ratio (PB ratio) value of Mahanagar Gas Ltd is 4. Benjamin Graham’s PE*PB number is 70.4, which is much higher than 22.5. Therefore, it provides very less margin of safety.
- Earnings Yield (EY) of Mahanagar Gas Ltd is 6%, which is less than government securities (G-sec) 10-year bond yield of 8.3%. Therefore, it provides no margin of safety.
- PEG ratio of Mahanagar Gas Ltd is 21.4% for 2018 and 26.5% for 2017. PEG ratio is less than 1 and therefore, it provides some margin of safety.
- Dividend Yield: current dividend yield of Mahanagar Gas Ltd is 2.2%. The company is consistently giving dividends.
- FCF/CFO = 52%
Mahanagar Gas Ltd has generated CFO of ₹3, 988 cr with only ₹1,919 cr capex requirement. This indicates the company is able to meet capex requirement without raising any Debt. In addition, the company has distributed dividends of ₹1,306 cr for the last 10 years. As per the guidelines of Dr. Vijay Malik (Ref: his Peaceful Investing e-book) we can give a premium of 2% (over 25-30% level of FCF/CFO ratio)
There is almost no margin of safety for investing in Mahanagar Gas Ltd at the current level.
Management analysis of Mahanagar Gas Ltd
I have searched all the directors of Mahanagar Gas Ltd for any fraud reported with their names online. There are no cases reported for any of the directors.
Two major entities (GAIL and BG Asia) have nominated their directors on the board of Mahanagar Gas Ltd. The salary paid to them is by the principal’s companies except for basic amenities like a car, phone, and rent.
The salary paid is less than 5% of profits of Mahanagar Gas Ltd.
Further analysis of annual reports of Mahanagar Gas Ltd creates some doubt about management though.
- The corporate social responsibility (CSR) spend for FY2016 is ₹4.6 cr against required ₹8.89 cr.
- For 2017, CSR spending is ₹4.69 cr against the required amount of ₹9.09 cr.
- For 2018, the spending on CSR is ₹2.94 cr against the requirement of ₹9.99 cr.
Consistently, Mahanagar Gas Ltd is not spending the required money on CSR.
In addition, there is an inconsistency in spending the CSR funds as well. For animal welfare, it planned to spend ₹2.17 cr and it spent ₹0.73 cr for the sterilization of 1,000 stray dogs. It did not match the planned spending and results achieved. This CSR spend is discontinued in FY2018.
Credit Ratings of Mahanagar Gas Ltd
- AAA for long-term and A1+ form ICRA – June 2018 report
- AAA for long-term and A1+ form ICRA – May 2017 report
- AAA for long-term and A1+ form ICRA – April 2016 report
- No pricing power as the government has full control over prices
- Last mover disadvantage for a utility company (electricity, water supply) in Mumbai. In addition, there is a space constraint for future growth in Mumbai.
- No competitor can replace the 5,042 km pipeline network of Mahanagar Gas Ltd. Moreover, the regulatory approvals (Municipal Corporation’s approvals for digging the roads) is also challenging for any new entrant. There will be a switching cost also for the customer. This creates some monopoly for the business of Mahanagar Gas Ltd.
Mahanagar Gas Ltd has acknowledged the challenge of developing the network in Raigad in FY2016 annual report.
Still, Mahanagar Gas Ltd has not completed the project on time. When we refer the FY2018 annual report, then we notice that Mahanagar Gas Ltd has to submit corrective actions to Petroleum and Natural Gas Regulatory Board (PNGRB).
Inconsistencies in reporting on initiatives:
There is no mention of how many two-wheelers are served in the FY2018 annual report of Mahanagar Gas Ltd. However, in FY2016 and FY2017 annual reports, Mahanagar Gas Ltd has highlighted the addition of two-wheeler CNG option as a key initiative.
Peer Analysis of Mahanagar Gas Ltd
- Gujarat State Petronet Ltd (GSPL) and Indraprastha Gas Ltd (IGL) can be considered peers to MGL.
- Sales growth for all the peers shows a similar trend as MGL for the last three years. This is because of the reduction of natural gas prices. However, for IGL and GSPL, the growth is 8% and for MGL it is only 2%. However, over last 10 years, IGL has grown to 21%, MGL 15%, and GSPL 12%.
- Operating profit margin (OPM) for IGL and MGL is in tune of 23 to 35%. However, for GSPL, it is 87%. Net profit margin (NPM) for MGL is 14% to 27%, for IGL 9% to 22% and for GSPL 25 to 50%. OPM and NPM of GSPL are much higher than MGL.
- Debt for Mahanagar Gas Ltd is always close to zero. IGL, over the years, has reduced debt to zero. However, GSPL has constantly raised debts. Mahanagar Gas Ltd has always done capex through internal accruals instead of debt in this capex heavy industry.
- Net fixed asset turnover is in the range of 1.5 to 2.0 for Mahanagar Gas Ltd and IGL but for GSPL it’s 0.42.
- Receivables days for Mahanagar Gas Ltd has improved continuously from 42 days to 15 days while for IGL it is maintained around 15 days and for GSPL it went to 88 days in 2014 and now at 33 days.
- Inventory turnover for Mahanagar Gas Ltd (94) is better than IGL (82) and GSPL (11).
- Mahanagar Gas Ltd is consistently paying dividends to the tune of 40-50%. IGL and GSPL are not consistent in their dividend payout.
Despite operating in an asset-heavy industry, Mahanagar Gas Ltd has maintained low debt levels and increased the customer base. It has been consistently paying dividends. Mahanagar Gas Ltd has maintained its operating and net profit margins throughout the years of changes of natural gas prices even when the input and output prices are governed by external factors. The credit rating of Mahanagar Gas Ltd is AAA, which is a good sign. However, the project execution is a challenge in Raigad area. It seems that the management of Mahanagar Gas Ltd acknowledges the failure and that it has taken no corrective actions. On the valuations front, the PE ratio of Mahanagar Gas Ltd is more 17.5. Overall, Mahanagar Gas Ltd is a conservative stock (a slow grower), which can be added in the portfolio when PE ratio is below 12.
Dr Vijay Malik’s Response
Thanks for sharing the analysis of Mahanagar Gas Ltd Limited with us! We appreciate the time & effort put in by you in the analysis.
Let us analyse the performance of Mahanagar Gas Ltd over the last 10 years.
Financial Analysis of Mahanagar Gas Ltd:
While analyzing the financials of Mahanagar Gas Ltd, an investor would note that in the past (FY2009-18), the company has been able to grow its sales at a moderate rate of 10-15% year on year. Sales of the company increased from ₹639 cr. in FY2009 to ₹2,233 cr in FY2018. The growth in the sales of the company has not been smooth. The company witnessed its sales increase steadily from FY2009 up to FY2015. However, sales of Mahanagar Gas Ltd witnessed a decline during FY2016 and FY2017 when the sales of the company reduced from ₹2,095 cr. in FY2015 to ₹2,034 cr. in FY2017. In FY2018, the sales of the company have increased to ₹2,233 cr.
An investor would appreciate that the price of the gas to the end consumer is linked to the crude oil prices. Mahanagar Gas Ltd gets its supply of natural gas from two sources:
- Domestic gas allocation under administered pricing mechanism (APM), which is allocated for piped natural gas (PNG) supply to homes and compressed natural gas (CNG) for vehicles and
- Purchase from the market for supply to industrial and commercial units.
PNG and CNG are the dominant sales categories for Mahanagar Gas Ltd, as they constitute about 85% of total sales. Industrial and commercial sales constitute the rest. The following chart from the investor presentation of Mahanagar Gas Ltd with Q1-FY2019 results (Page 13) shows the sales revenue from each segment:
Mahanagar Gas Ltd get the natural gas for supplying to residential customers (PNG) and vehicles (CNG) under APM whereas it has to source the natural gas for supply to commercial and industrial units from the market.
The price of gas from these two sources of natural gas differ from each other with APM gas being cheaper than market/spot purchase. However, the trend of the change in the price of natural gas from both these sources is similar. Petroleum and Natural Gas Regulatory Board (PNGRB) decides the price of APM gas based on a formula containing the inputs influenced by crude oil prices.
An investor would notice that the sales revenue of Mahanagar Gas Ltd declined in FY2016 and FY2017, which coincides with the period of the sharp correction in crude oil prices. During this period, the crude oil prices declined from about $110 per barrel to $30 per barrel. The below chart of the price changes of NYMEX crude over the last 10 years shows the sharp decline in crude oil prices in recent past (Source: macrotrends.net)
When an investor analyses the change in the price of domestic natural gas under the APM decided by PNGRB since FY2015, then she notices that the price of gas under APM has mirrored the change in the crude oil. The below chart shows the changes in the APM decided by PNGRB over the years:
An investor would notice that during FY2016 and FY2017, the price of domestic natural gas under APM declined as the crude oil prices were falling. The price of natural gas under APM declined more than 50% from the level of $5.05/MMBTU for H2-FY2015 to $2.50/MMBTU for H2-FY2017.
As a result, Mahanagar Gas Ltd had to pass on the benefits of the lower natural gas prices to its customers. This, in turn, resulted in the decline in the sales revenue for Mahanagar Gas Ltd despite a consistent increase in the overall volume of the natural gas sold by it. It illustrates that the positive impact of the sale of higher volumes of natural was by Mahanagar Gas Ltd was not sufficient to overcome the negative impact from the decline in the sales price of natural gas. The following chart from the investor presentation of Mahanagar Gas Ltd with Q1-FY2019 results (Page 21) shows that over the years, it has grown its sales volumes of CNG and PNG at a CAGR of about 5%.
The above analysis indicates that the prices charged by Mahanagar Gas Ltd to its customers are dependent on the price of its raw material (natural gas), which in turn is dependent on crude oil prices.
This aspect of the linkage of the sales price of the natural gas sold by Mahanagar Gas Ltd with the cost of natural gas is highlighted by ICRA in its credit rating report for May 2015:
The domestic gas prices were increased to US$ 5.6/ MMBTU w.e.f Nov 1, 2014 which resulted in an increase in gas sourcing costs for MGL and the same was passed on to the consumers by increasing CNG prices by Rs. 4.50/ kg.
Therefore, investors should expect that as the crude oil prices increase in the future, then Mahanagar Gas Ltd would be able to show higher sales revenue. On the similar lines, if the crude oil prices decline in future, the sales revenue for Mahanagar Gas Ltd may fall in future.
Further advised reading: How to do business analysis of companies?
Now let us analyse the profitability parameters of Mahanagar Gas Ltd. Whenever, investors come across companies, which have their final product prices fully benchmarked to the price of raw material, then investors would notice that such companies usually follow two types of pricing formulas with the customers:
- Scenario 1: In the first scenario, the company adds a fixed percentage of profit margin over the raw material cost and then quotes the final price to the customer. In most such cases, the profit margins stay constant irrespective of the changes in the raw material costs. E.g. if the profit margin in the formula is 20% and the raw material cost is ₹100, then the customer will be asked to pay ₹120. If the raw material price falls to ₹50, then the customer will be asked to pay ₹60. In both the cases, the profit margin will stay constant at 20%. When we interpret it in an inverse manner, then we notice that the cost of raw material as a percentage of sales stays constant i.e. 100/120 = 50/60 = 83.3%
- Scenario 2: In the second scenario, the company adds a fixed amount (₹/$) of profit amount on the raw material and asks the customer to pay the final price. In such cases, the profit margin of the company increases when the raw material costs decline and vice versa. E.g. if the fixed profit amount to be added is ₹20 and the cost of raw material is ₹100, then the final product price will be ₹120 and the profit margin will be 20%. On the contrary, if the raw material price decline to ₹50, then the final product price will be ₹70 and the profit margin will be 40%.
- In Scenario 2, the cost of raw material as a percentage of sales will keep changing i.e. 100/120 = 83.3%, 50/70 = 71.4%.
- An investor would appreciate that in scenario 2, as sales increase due to increase in raw material prices (which are passed on to customers resulting in higher sales), the raw material costs as a percentage of the sales increase. E.g. in the above example, the raw material costs are 83.3% of sales when the sales are ₹120.
- On the contrary, when the sales decline due to a decrease in raw material costs (when the benefit of lower costs is passed on to the customers), the raw material costs as a percentage of sales witness a decline. E.g. in the above example, the raw material costs are 71.4% when the sales are ₹70.
Looking at the two most common scenarios of full/complete benchmarking of final product prices with the raw material costs, an investor would appreciate that the raw material costs as a percentage of sales of such companies will show any of the two patterns:
- Either the company will have stable raw material costs as a percentage of sales (scenario 1) or
- The raw material costs as a percentage of sales will increase when the sales increase or raw material costs as a percentage of sales will decrease when the sales decline (scenario 2).
Out of these two scenarios of benchmarking, we believe that the scenario 2 in which the company adds a fixed amount (₹/$) of profit on the raw material cost, is highly beneficial to the companies. This is because, in the case of scenario 2, the company is assured of a fixed amount of profit, which it needs to meet other expenses like employee costs, administration expenses etc.
In case of scenario 2, the shareholders can be assured that irrespective of the level of raw material costs, the company will earn at least a fixed sum of profit per unit of product, which it will use for meeting all other operating costs and in turn pay a dividend as well. Therefore, in the case of scenario 2, when the company adds a fixed amount of profit amount on the raw material costs, the shareholders can stay relaxed irrespective of the changing costs of raw materials. In the example cited above, the company earns a profit of ₹20 whether the raw material cost is ₹50 or ₹100.
On the contrary, in case of scenario 1 where a company adds a fixed percentage profit (in contrast to the addition of a fixed amount (₹/$) of profit in case of scenario 2), the company is continuously exposed to the risk of changing raw material prices. This is because in scenario 1, as the raw material prices decline, the amount of profit earned by the company also declines. In the example cited above (stable 20% profit margin), when the raw material cost was ₹100, then the company earned ₹20 as profit (20%). Whereas when the raw material cost declined to ₹50, then the amount of profit declined to ₹10 (20% profit). Therefore, in the case of scenario 1, whenever the raw material costs decline, then the amount of profits available with the company to meet other operating expenses like employee, administration costs etc. declines. As a result, the company faces challenges to meet its costs when the raw material costs decline.
A live example of a company facing the consequences of benchmarking under scenario 1 is the case of Nile Ltd, which is a key supplier to Amara Raja Batteries Ltd. It seems that Nile Ltd has a contract with Amara Raja Batteries Ltd, which provides a fixed percentage of profit over the raw material costs. As a result, Nile Ltd has witnessed its profit margins decline to low levels when the cost of the key raw material (Lead) declined. Nile Ltd reported operating losses in FY2009 when the Lead prices witnessed a sharp decline.
For further details and learning about such cases suffering under scenario 1 benchmarking, an investor may read the analysis of Nile Ltd on our website here:
Further advised reading: Analysis: Nile Ltd.
To find out the nature of the benchmarking followed by Mahanagar Gas Ltd (out of scenario 1 and scenario 2), an investor needs to see the changes in the raw material costs as a percentage of sales over the years as the sales revenue of the company changed.
If an investor notices that the raw material costs as a percentage of sales of a company are stable over the years, then it may indicate that it is following scenario 1 benchmarking of passing on the costs to its customers (i.e. a fixed percentage of profit over the raw material costs). However, if the raw material costs as a percentage of sales increase when sales increase and raw material costs as a percentage of sales decline when the raw material costs decrease, then it would indicate that the company is following scenario 2 benchmarking (a fixed ₹/$ of profit amount over raw material costs).
The following chart shows the raw material costs as a percentage of sales for Mahanagar Gas Ltd over the years.
On the analysis of the above chart, an investor would notice that since FY2011, the raw material costs as a percentage of sales for Mahanagar Gas Ltd have increased step in step with the increasing sales. Since FY2016, when the sales of the company declined due to declining crude oil and natural gas prices, then the raw material costs have declined as well. Such kind of pattern of changing raw material costs as a percentage of sales with changing sales revenue (due to passing on of increase/decrease of raw material costs) is a feature of Scenario 2 benchmarking (a fixed ₹/$ amount of profit per unit of sales). As discussed above, scenario 2 benchmarking is beneficial for the companies as the company can stay assured of a fixed amount of profit irrespective of the changing raw material costs.
Moreover, while looking at the above chart of changing raw material costs as a percentage of sales for Mahanagar Gas Ltd, an investor would notice that during FY2011-15, the increase in raw material costs as a percentage of sales is well aligned to the increasing sales. Whereas during FY2016 and FY2017, when the natural gas prices declined and as a result, the sales declined, the raw material costs as a percentage of sales of Mahanagar Gas Ltd have witnessed a much sharper decline than the comparative decline in sales. This indicates that the company has not passed on the full benefit of the declining raw material costs to its customers.
Mahanagar Gas Ltd seems to have reduced the prices to the customers only partly when compared to the benefit it got from the PNGRB in terms of lower APM gas prices. It also gets established when an investor analyses the credit rating report of Mahanagar Gas Ltd by ICRA for May 2017:
In line with fall in global gas prices, the domestic gas prices too have declined by 20% for the 6-month period from April 2016 and then by 18% for the six-month period from October 2016. The latest announced price of US$2.48/mmbtu 1 is 1% lower for the next six-month period starting from April 2017. The company has passed on the benefits of lower gas cost to customers partially with a reduction in CNG prices and has managed to retain part of the benefits resulting in higher contribution margin.
Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors
The increasing natural gas costs along with scenario 2 (fixed ₹/$) benchmarking illustrate the declining profitability of Mahanagar Gas Ltd over FY2011-2015 when crude oil prices and natural gas prices were high. The declining natural gas costs as a percentage of sales along with partial retention of benefits when crude oil and natural gas prices were declining in the recent past explain the recent sharp increase in profit margins of Mahanagar Gas Ltd from 23% in FY2016 to 34% in FY2018.
An investor may also refer to the gross margin per standard cubic meter (SCM) of natural gas sold by Mahanagar Gas Ltd as disclosed by the company in its investor presentation of August 2018, page 25:
The above table indicates that the profit margin of Mahanagar Gas Ltd per unit of sale of natural gas has increased continuously since FY2014 irrespective of changes in the crude oil prices or natural gas prices under APM. Such data clearly indicates that Mahanagar Gas Ltd is following scenario 2 benchmarking and is even able to retain the benefits of declining raw material prices.
Further advised reading: How to do Financial Analysis of Companies
Operating Efficiency Analysis of Mahanagar Gas Ltd:
When an investor analyses the net fixed asset turnover (NFAT) of Mahanagar Gas Ltd, then she notices that the NFAT of the company has consistently been in the range of 1.50 to 2.00 over the years (FY2009-18). During the initial years (FY2011-15), the NFAT increased from 1.45 to 2.04. It seems due to the completion of major capital expenditure in the Mumbai and Thane region where it has been getting incremental customers from the key pipeline infrastructure, which it has created.
From FY2016 onwards, Mahanagar Gas Ltd has increased capital expenditure. One of the key areas requiring a lot of capital expenditure currently is the Raigad region where the company has to create the entire pipeline and CNG station network. Because of the heavy capital expenditure, which will lead to results/revenue in the future, the NFAT of Mahanagar Gas Ltd has declined in recent years from 2.04 in FY2015 to 1.57 in FY2018.
An investor would note that over the years, the inventory turnover ratios (ITR) of Mahanagar Gas Ltd have been very high in the range of 90 to 100 and on occasions exceeding the levels of 120 as well. Such high levels of inventory turnover indicate that Mahanagar Gas Ltd does not need to maintain high inventory when compared to its sales. This is true as the product of the company, natural gas, is simultaneously fed into the pipelines and consumed. It does not need to store a large amount of gas for supplying to customers many months down the line.
Over the years, Mahanagar Gas Ltd has been able to keep its receivables days very low in the range of 15-20 days. This is because most of the sales of the company (73%) are to automobiles fitted with CNG, where the vehicle owners pay the money whenever they fill the gas. The next major segment of sales (12%) is residential customers (PNG), which pay the bills within 15-20 days after the bill is generated. Therefore, Mahanagar Gas Ltd has a very low level of receivables.
Further Advised Reading: Receivable Days: A Complete Guide
Looking at the performance of Mahanagar Gas Ltd on both the aspects of inventory and receivables, an investor would notice that the company is doing well at both these fronts. The company does not need to maintain a large inventory and it collects its receivables very soon. Therefore, the operations of Mahanagar Gas Ltd need only low levels of working capital.
The ability of the company to keep its working capital efficiency within control by keeping ITR and receivables days under check indicates that the company has been able to convert its profits into the cash flow from operations without the money being stuck in working capital. An investor observes the same while comparing the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of the company for FY2009-18.
An investor would notice that over FY2009-18, Mahanagar Gas Ltd Limited has reported a total cumulative net profit after tax (cPAT) of ₹2,921 cr. whereas during the same period, it reported a cumulative cash flow from operations (cCFO) of ₹3,988 cr indicating that it has converted its profits into cash.
Further advised reading: Understanding Cash Flow from Operations (CFO)
Margin of Safety in the Business of Mahanagar Gas Ltd:
Free Cash Flow Analysis of Mahanagar Gas Ltd:
While looking at the cash flow performance of Mahanagar Gas Ltd, an investor notices that during FY2009-18, the company had a cumulative cash flow from operations of ₹3,988 cr. However, during this period it did a capital expenditure (capex) of ₹1,919 cr. Mahanagar Gas Ltd could meet the entire capex from its own sources. As a result, it had a free cash flow (FCF) of ₹2,069 cr (= 3,988 – 1,919) over FY2009-18. In addition, the company had a non-operating/other income of ₹326 cr. over the same period.
As a result, the company did not need to raise any debt for meeting its capital expenditure plans. It could use the free cash available with it to pay dividends to shareholders and still left with surplus funds. At March 31, 2018, the company has a negligible debt of ₹1 cr. and cash & investments of about ₹780 cr.
Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF
Free cash flow (FCF) is one of the main pillars of assessing the margin of safety in the business model of any company.
Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing
Additional aspects of Mahanagar Gas Ltd
On analysing Mahanagar Gas Ltd, an investor comes across certain other aspects of the company:
1) Government ownership of Mahanagar Gas Ltd:
On September 30, 2018, the largest shareholders of Mahanagar Gas Ltd are Govt. entities:
- 32.5% is owned by GAIL (India) Ltd, which is a public sector unit (PSU) and
- 10% is owned by Govt. of Maharashtra
The erstwhile large shareholder, British Gas, which originally used to own 49.5% shareholding, currently own only 10% of the stake in the company. Minority shareholders own rest of the shareholding of the company.
An investor would note that accordingly to the current shareholding pattern of Mahanagar Gas Ltd, it has almost become a public sector unit (PSU).
We believe that while investing in Mahanagar Gas Ltd, investors should be aware of the key aspect of investing in any PSU:
- Govt. starts PSUs for the specific purpose of public good.
- PSUs have the primary aim of meeting the purpose and agenda of Govt.
- Profit making for the largest shareholder (Govt.) or minority shareholders is not the primary aim of PSUs.
- As a result, many times, investors would notice that PSUs do not prioritize maximization of shareholders’ wealth as their key goal. Instead, PSUs take their decisions to fulfill the vision of the largest shareholder (Govt.).
In the recent past, there have been many instances have PSUs have played their part in the vision of public good as per Govt. agenda. In many such cases, minority shareholders have felt that the PSUs could have generated greater profits for them. An investor may notice the following cases as some examples:
- Oct. 2018: Central Govt. asks oil marketing companies (OMCs) to bear subsidy burden of ₹1 per liter of automobile fuels and as a result, the stocks of OMCs: BPCL, HPCL, IOC decline significantly. (Source: Business Today: Petrol, diesel impact: Oil companies’ stocks lose Rs 1.25 lakh crore in last two trading sessions).
- May 2018: OMCs did not change the fuel prices for about 19 days as elections in the state of Karnataka were taking place. Previously, under fuel price deregulation, OMCs used to update the fuel prices daily in line with changing crude oil prices. (Source: India Today: Was fuel price freeze during Karnataka’s poll season a result of political influence?).
- Oct 2012: Coal India Limited (90% owned by Govt. of India), which has a near monopoly for supplying coal in India, reversed the fuel price hike announced in Dec 2011. The Children’s Investment (TCI) Fund, which owned 1% stake in Coal India, sued the company and the Govt. of India in the court stating that the company lost about ₹8,700 cr. due to the price increase reversal. (Source: India Times: The Children’s Investment Fund sues government, Coal India directors over loss).
- However, finally, The Children’s Investment (TCI) Fund sold its entire stake in Coal India Limited (Source: First Post: Why The Children Investment Fund’s exit from Coal India matters).
Therefore, investors of Mahanagar Gas Ltd just like investors of any PSU should keep it in mind that many times, the decisions of the company might not be aligned to generate maximum profits for the shareholders. The largest shareholder (Govt.) may influence the decisions of the company in line with what it thinks is in the best interests of the public at large.
Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?
2) Significant decline in the stake of the founding promoter, British Gas:
Mahanagar Gas Ltd was started as a joint venture (JV) between GAIL (India) Ltd and British Gas. While reading the draft red herring prospectus (DRHP), an investor comes to know that as a part of the permission for setting up this JV, the Foreign Investment Promotion Board (FIPB) had stipulated a few conditions. One of the condition was that the promoters (Gail and British Gas) would have to dilute their shareholding so that Govt. of Maharashtra owns 10% and the public owns 20% of the stake in Mahanagar Gas Ltd.
DRHP, Mahanagar Gas Ltd, page 23:
We have not been, and currently are not, in compliance with Foreign Investment Promotion Board’s (“FIPB, direction to reduce our shareholding of the Promoters in our Company. Further, as per the direction of FIPB, we have filed a compounding application with RBI for non-compliance for the period January 2007 to March 2008. Any adverse action taken by RBI against our Company in this regard may adversely affect our cash flows and results of operations.
FIPB had granted its permission to British Gas plc (now known as BG Transco), for setting up a joint venture for city gas distribution, through its letter dated February 28, 1994 (“FIPB Letter I”). Pursuant to the FIPB Letter I, FIPB had noted that while initially the two joint venture partners would hold equal stake in the Company, subsequently the public and the Government of Maharashtra would be required to hold 20% and 10% of the Equity Shares, respectively. We have sought and received extensions from FIPB in the past for meeting the aforementioned condition, and were recently granted another approval for our Company’s proposal to undertake the initial public offer by December 2015 (“FIPB Letter II”), subject to market conditions. The FIPB Letter II also prescribed certain terms and conditions including filing of a compounding application before RBI, for non-compliance for the period January 2007 to March 2008. Consequently, we have filed an application with RBI on September 21, 2015 for initiation of compounding proceedings, for non-compliance of the conditions stipulated by FIPB Letter II and are currently awaiting its response.
By reading the above conditions, an investor would appreciate that the regulations directed for the promoters of Mahanagar Gas Ltd to reduce their stake in the company in the future. However, it remains to be seen whether the recent significant reduction of stake by one of the founding promoters of the company, British Gas, is a result of any regulatory guidelines or it is a commercial decision. Investors may seek clarifications from the company about the reasons for the significant sale of stake by British Gas in the company.
Further advised reading: Steps to Assess Management Quality before Buying Stocks
3) Project delays due to requirement of multiple approvals:
Mahanagar Gas Ltd operates in an industry in which the execution of any project requires multiple approvals. The following comment by the management of the company in its August 2018 conference call (page 18) indicates the significant number of approvals needed for its projects:
Vishnu Kumar: In your experience how much of state government approvals would be required to get once you get from PNGRB and typically what is your assessment in terms of the approvals timeline that will take from the state government?
Management : That will depend from state to state and more than state government approvals usually the local bodies and the municipal authorities, etc., whose approval is important and it is not just them you have the highway authority, you have railways, host of other development authorities whose approvals are required, so it is not very easy thing, it takes time.
Further advised reading: How to Monitor Stocks in your Portfolio
As accepted by the management of the company, obtaining so many approvals is not an easy task. Many times, projects are delayed due to lack of approvals, which may be beyond the control of the company. However, such delays, even if they are beyond the control of the company, may involve financial penalties by PNGRB if the project work is not completed in time.
Mahanagar Gas Ltd is facing a similar situation in case of its project work in Raigad district where it is laying down the natural gas pipeline and distribution infrastructure. The company is not able to meet its project deadlines due to delays in approvals from statutory bodies, which are beyond the control of Mahanagar Gas Ltd.
Credit rating report, ICRA, May 2017, page 3:
During the last two fiscals, the company incurred limited capex in Raigad, significantly lower than the MWP, mainly due to delay in regulatory approvals, which are beyond the scope of the company.
Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors
Because of these delays, Mahanagar Gas Ltd has submitted a remedial action plan to PNGRB.
The FY2018 annual report, page 160:
The Company is yet to achieve MWP target specified up to 31st March 2018 in Raigarh GA. To achieve cumulative MWP required up to 2019-20, the Company as per regulation 16 of the PNGRB regulations GSR 196 (E), basis the Minutes of Meeting of the PNGRB hearing dated 12th March 2018, has submitted the remedial action plan completing by 2020-21 to PNGRB on 4th April 2018.
Investors should keep a track of the developments related to Raigad project and the actions taken by PNGRB if any. An investor should be aware that many times in the past, the delays in approvals from statutory authorities have been so long that the multiple projects have become unviable due to resultant cost escalations.
4) Intention of acquiring stakes in other city gas distribution (CGD) companies:
As per FY2015 annual report, page 3, Mahanagar Gas Ltd is looking forward to acquiring stakes in other CNG distribution companies.
Your Company is looking for acquiring stake in other existing CGD entities having established markets. It is also pleasing to inform you that your Company is bidding for new geographical areas to set up and operate CGDs.
Further advised reading: Understanding the Annual Report of a Company
Investors should keep a close watch on any development on this front. It is essential to know that the price paid by Mahanagar Gas Ltd for any such acquisition is reasonable.
5) End of exclusive selling/marketing rights in Mumbai and Thane regions:
The exclusive selling/marketing rights of Mahanagar Gas Ltd in the Mumbai and Thane region have ended. Therefore, currently, other competing entities may use the infrastructure of Mahanagar Gas Ltd to supply natural gas to different customers in Mumbai and Thane region. These competitors need to pay Mahanagar Gas Ltd charges for using its pipeline infrastructure for supplying gas to their customers.
The marketing exclusivity of Mahanagar Gas Ltd ended in Mumbai region in 2012 and in Thane region in 2014. However, until now, no other competitor has used its pipeline network to supply gas to customers in Mumbai and Thane region.
As per Mahanagar Gas Ltd, the cost of natural gas to any competitor in Mumbai and Thane region will be higher than the cost of natural gas to Mahanagar Gas Ltd. This is because, in addition to the procurement cost of natural gas, the competitor will also have to pay the network charges to Mahanagar Gas Ltd for using the pipelines (network tariff).
FY2018 annual report, page 39:
First Mover Advantage: MGL is well placed with domain expertise and capacity to have access to the most cost competitive priced gas. For any new entrant aiming to compete with MGL (Shipper), usage of MGL’s distribution network would require them to pay an additional transportation tariff to MGL and thereby increasing its costs as compared to MGL.
Further advised reading: Understanding the Annual Report of a Company
An investor should keep in mind that the above assumption holds true if the cost of procurement of natural gas is same for Mahanagar Gas Ltd and the competitors proposing to use its pipelines to supply natural gas to customers in these regions. In case, any competitor is able to lower the cost of procurement of natural gas than Mahanagar Gas Ltd like in case of any entity directly owning the natural gas production fields, then the cost barrier might break. This, in turn, may lead to significant competition for Mahanagar Gas Ltd as in such cases; Mahanagar Gas Ltd cannot increase the network tariff indiscriminately to kill the competition. In case of any such predatory moves by Mahanagar Gas Ltd, the Competition Commission of India (CCI) and PNGRB may intervene to control the network tariffs to ensure the presence of fair competition.
Moreover, while analysing the rating methodology document (Dec 2016) used by credit rating agency ICRA for rating of city gas distribution (CGD) companies (Source: ICRA), an investor comes to know that many bidders have put in very aggressive bids to win the CGD blocks. Rating Methodology for City Gas Distribution Companies, Dec 2016, ICRA, page 4:
Several of the bidders have made aggressive bids, with reference to network & compression tariff (at nearly nil rates). The strategy of quoting low tariff could expose the aggressive bidders to competition once the exclusivity period is over; any third-party marketer could use the network of the successful bidder at a nominal cost and sell gas to current or new customers in the region.
Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors
As per the above document, many times, the aggressive bidders have quoted nil network tariff, which means that once the marketing/selling exclusivity period is over, then the third-party natural gas suppliers can use their pipeline networks at very low costs to supply gas to customers in their region.
Investors may seek clarifications from Mahanagar Gas Ltd about the exact amount of network tariff/costs third-party suppliers may need to pay to it for using its pipeline infrastructure. This data will help investors in making an informed assessment of the competition that may arise for Mahanagar Gas Ltd from third-party natural gas suppliers.
Please note that an investor may use rating methodology documents of credit rating agencies to learn the analysis of companies in industries, which are new to her.
Further advised reading: How to Analyse New Companies in Unknown Industries?
6) Contingent liability: Monetary demand from GAIL (India) Ltd:
While analysing the contingent liabilities section of the FY2018 annual report (page 161) of Mahanagar Gas Ltd, an investor gets to know about a demand of ₹137 crore by GAIL (India) Ltd for additional transportation tariff since November 2008 until March 2018. Investors also get to know that the additional tariff demand under dispute is increasing every year.
Demand from GAIL (India) Limited in respect of additional transportation tariff for the period from November 2008 to March 2018 ₹13,721.60 Lakh (previous year ₹12,252.59 Lakh). The company has filed an appeal before Appellate Tribunal for Electricity (APTEL).
Further advised reading: Understanding the Annual Report of a Company
As per Mahanagar Gas Ltd, it has contested this demand and has filed an appeal in the appellate tribunal. Investors should note that Mahanagar Gas Ltd might have needed to go to an appellate tribunal when the original authority had given a decision against the company. Therefore, investors should keep a close watch on the developments related to this dispute. This is because an outflow of ₹137 cr. is significant at a time when the company is looking at a large capital expenditure to develop Raigad region and has bid for three new blocks in the latest round of bidding by PNGRB.
7) Pending IPO expenses after about 2 years:
Mahanagar Gas Ltd came up with its initial public offer (IPO) in June 2016. However, an investor notices that even on March 31, 2018, the company has certain IPO expenses of about ₹13 cr. payable to its related parties (probably to GAIL (India) Ltd.).
The FY2018 annual report, page 153:
An investor also notices that Mahanagar Gas Ltd has earmarked about ₹12 cr. in the current account for these expenses.
The FY2018 annual report, page 143:
Further advised reading: Understanding the Annual Report of a Company
An investor may seek clarifications from the company about the nature of these expenses to related parties about IPO, which are still unpaid. What are these expenses? Whether there is any dispute about these expenses. In addition, the reasons that the money of ₹12 cr. is held in the current account, which does not earn any interest, instead of holding it in fixed deposits.
As per page 66 of the FY2018 annual report, Mahanagar Gas Ltd has spent only ₹3 cr. out of about ₹10 cr., which it needed to spend on CSR. Investors may monitor whether the company spends the deficit amount of about ₹7 cr. on the CSR activities in future years.
Margin of Safety in the market price of Mahanagar Gas Ltd:
Currently (October 16, 2018), Mahanagar Gas Ltd is available at a price to earnings (PE) ratio of about 17 based on earning of past four quarters ending June 2018. The PE ratio of 17 does not offer any margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.
In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.
- Further advised reading: 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- Read: How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Further advised reading: Hidden Risk of Investing in High P/E Stocks
Overall, Mahanagar Gas Ltd seems like a company, which has a stable business model having a monopoly of natural gas distribution in Mumbai and Thane region. The company has set up most of the pipeline infrastructure in these regions and is currently adding incremental customers within these regions with established gas distribution infrastructure.
Mahanagar Gas Ltd has the ability to pass on increases in the cost of its raw material (natural gas) to its customers. Moreover, it has been able to retain part of the benefits with itself when the natural gas prices have declined. As a result, the company has witnessed its profit margins increase in recent years when the prices of crude oil and natural gas have declined.
The business of Mahanagar Gas Ltd is capital intensive, as it has to spend a lot of money in capital expenditure on laying the gas pipeline network before it can start earning money by supplying gas to customers. The capital-intensive business along with the requirement of a lot of regulatory approval creates many barriers to entry in this field. However, as part of aggressive bidding by different entities for allotment of city gas distribution (CGD) blocks even at almost nil network tariff, the companies may see competition from third-party gas suppliers who may use the pipeline network of the CGD allottee companies at low cost.
Mahanagar Gas Ltd enjoys very low working capital requirements in its business as almost three fourth of its business is done on cash payment basis at the CNG pumps where vehicle owners pay whenever they fill gas. As a result, the company has been able to generate free cash flow without money being stuck in working capital with increasing business.
Currently, Mahanagar Gas Ltd is developing a pipeline network in Raigad district and has applied for three more CGD blocks in the latest round of bidding by PNGRB. These ventures entail significant capital expenditure going ahead. Investors need to monitor the capital spent on these new projects as well as the timely development of these regions. This is especially important as the development of pipeline networks need many regulatory approvals, which may take a long time to come, which is beyond the control of the company and as a result, the company may suffer cost escalations as well as regulatory penalties for delay in meeting project deadlines.
Until now, Mahanagar Gas Ltd has been able to generate good profitability with significant free cash flow for its shareholders. However, as the largest shareholders of the company are govt.-controlled entities, therefore, investors should keep a track of different decisions of the company. It may happen that in future the company may take decisions, which are influenced by the vision of the largest shareholder, which may not align with the aim of generating maximum profits for shareholders.
Investors may seek clarification from Mahanagar Gas Ltd about certain aspects like reasons for the significant sale of stake by one of its promoters, British Gas, the amount of network tariff quoted by the company in its bid for third-party gas suppliers, the reasons for IPO expenses still payable to related parties etc.
Going ahead, investors should keep a close watch on the development of gas distribution network in Raigad district, passage of complete cost of an increase in natural gas prices when APM gas prices increase in future, valuation of acquisition of a stake in any other CGD player. Investors should also monitor the amount of capital expenditure to be done on the new blocks and its sources if it wins in the latest round of bidding for CGD blocks.
Further advised reading: How to Monitor Stocks in your Portfolio
These are our views on Mahanagar Gas Ltd. However, investors should do their own analysis before taking any investment related decision about the company.
You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks”
Hope it helps!
Dr Vijay Malik
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Registration status with SEBI:
I am registered with SEBI as a research analyst.
Details of financial interest in the Subject Company:
I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.