Gas Companies - Ambit - Feb 2011

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February 23, 2011

Oil & Gas

THEMATIC

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit

Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to disclaimer section on the last page for further important disclaimer.

Analyst contact

Dayanand Mittal

Tel: +91 22 3043 [email protected]

Competitive advantages snapshot

IGL GGas

Gas sourcing abilities

Existing domestic gasallocation

Incremental domestic gasallocation

LNG sourcing capabilities

Sub-totalPricing power

Statewide tax structure forgas

Presence in high marginCNG business

Sub-total

Volume growth potential

Presence in high growth cities

Presence in high growthpotential CNG and PNGbusiness

Sub-total

Grant total

Source: Ambit Capital research

Note: - Very Strong, - Strong, - Weak,

- Very Weak

IGL BUY

CMP: `347

Target Price (12 month): `406Previous TP: NA

Upside (%) 17%

EPS (FY13): `23.9

Change from previous (%) NA

Variance from consensus (%) -3%

Gujarat Gas SELL

CMP: `393


Downside (%) -6%

EPS (CY12): `25.2Change from previous (%) NA


Dawn for a new utility sectorThe Consumer Gas Distribution (CGD) sector is witnessing high growthbut faces challenges ahead. We prefer Indraprastha Gas (IGL) overGujarat Gas (GGas) due to IGLs competitive advantages relating to:(a) High allocation of domestic gas, (b) Strong pricing power in thecompetitive CNG segment; and (c) Monopoly status in the huge (andtax friendly) NCR (National Capital Region) market. We initiatecoverage on IGL with a BUY and on GGas with a SELL.

The three key sources of competitive advantage in CGD are:

Gas sourcing ability: The CGD sector is in the midst of a high growth phasegiven its cost competitiveness and low penetration. However, the shortage oflow cost domestic gas (one-thirds the cost of LNG) is increasing gas

distributors dependency on high-cost LNG, which could potentially derail theCGD growth story. Hence we prefer companies which have a higherallocation of domestic gas and are likely to be preferred for incrementaldomestic gas allocation. Given the rising share of LNG in the gas mix, theability to source LNG at a competitive price is also a plus.

Pricing power: We prefer companies with exposure to CNG versus theIndustrial or PNG segment, as CNG is ~50% cost competitive versusderegulated petrol (due to high taxes on petrol). CNGs competitiveness couldfurther strengthen with the progress towards gradual diesel deregulation,driving up discretionary private conversion to CNG. CGD firms, which arepresent in cities that have a favourable tax policy for CGD, (eg. the NCR) tendto have greater pricing power.

Volume growth potential: Companies with an exclusive licence to operatein a city with huge gas demand have the first mover advantage and cancreate high barriers to entry to deter any competitive threat post the end ofthe exclusivity period. The CNG and PNG businesses have the highest growthpotential given: (a) CNG and PNG constitute a low 2.8% of Indias gasconsumption versus 10%-20% for most developed countries; and (b) Theregulatory push as the Government prefers CNG/PNG in its drive to controlpollution and reduce its fuel subsidy.

IGL (IGL IN, BUY, 17% upside): Our competitive advantage matrix showsIGL as the best placed firm to take advantage of the CGD opportunity. We prefer IGL due to: (i) Its high allocation of domestic gas due to its

exposure to Government-preferred CNG/PNG business and efficient sourcingof LNG given its strong parentage; (ii) Strong pricing power due to itssignificant presence in the competitive CNG segment and owing to favourabletax treatment for CGD in the NCR; and (iii) Strong volume growth potential(16% CARG over FY12-FY16) based on its exclusive licence to set up a CGDnetwork in the NCR market and a presence in the underpenetrated andGovernment-preferred CNG/PNG business. We believe the risk of marketingmargin regulation is priced in. Allocation of additional domestic gas, dieselderegulation and capping of the LPG subsidy are key positive triggers.

GGas (GGAS IN,SELL, 6% downside): GGass business model could facechallenges due to: (i) Rising dependency on LNG (due to decline in supplyfrom the matured PMT field) while its limited exposure to the CNG/PNGbusiness would mean low chance of incremental domestic gas allocation; (ii)Relatively weak pricing power due to its presence in the not-so-competitiveIndustrial segment and high taxes on CGD in Gujarat; and (iii) Volumegrowth stagnating at ~5% due to saturating Industrial segment demand.


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Ambit Capital Pvt Ltd 2

CONTENTS

SECTOR

A brief history of CGD in India ...........................................................3

The CGD supply chain in India...........................................................4

Regulation of the CGD sector .............................................................6

Sources of competitive advantage .....................................................9

We see IGL as the best CGD play.....................................................22

Marketing margin regulation impact? ............................................28

COMPANIES

Indraprastha Gas31

Gujarat Gas...45


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A brief history of CGD in IndiaCity gas distribution (CGD) essentially involves tapping of natural gas from trunkpipelines and feeding into smaller diameter pipes of the CGD network so as todistribute it amongst the small end users in urban areas such as cars (via CNG i.e.compressed natural gas), household and commercial segments (via PNG i.e. piped

natural gas) and SMEs.Historically, India has relied on: (i) oil for its transport sector; (ii) LPG (liquefiedpetroleum gas) for cooking by the household and commercial segments; and (iii)liquid fuel/coal/power for industrial consumers. Gas distribution within cities hashistorically been limited in India mainly because of the countrys low gas reserves,lack of infrastructure to import gas in the form of LNG (liquefied natural gas) andlimited pipeline network to distribute gas via pipelines across various cities.

Regulatory & judicial mandates laid the foundation for CGD in India

Thanks to international pressure to cut carbon emissions, India began to seriouslylook at cleaner fuels, including natural gas, in the 1990s. At the same time, theGovernment wanted to boost the countrys energy security by tapping Indias

domestic natural gas reserves and thereby lower its oil import bill. It is estimatedthat Indias natural gas reserves is equivalent to 27 years of consumption whereasits crude reserve amounts to less than 5.5 years of consumption. In addition, thecost competitiveness of gas versus liquid fuels adds to its attractiveness, with gasprices (in US$/mmbtu i.e. million British thermal units) in India ranging between6%-10% of crude prices (in US$/bbl) against 17% on an energy equivalence basis.

Thus, in the 1980s, the Government initiated techno-economic feasibility studiesfor gas distribution in Mumbai and Delhi through Sofragaz and British Gas. Basedon the encouraging recommendations of these studies, Mahanagar Gas Ltd (MGL)was incorporated in May 1995 and Indraprastha Gas Ltd (IGL), in December 1998.The Government allocated domestic gas to MGL and IGL for distribution as CNGto cars and as PNG to households in Mumbai and Delhi.

Development of the CGD was fast-tracked by the Supreme Courts July 1998 orderto contain vehicular pollution. The Court directed all buses, three wheelers andtaxis in Delhi to adopt CNG as a fuel by March 31, 2001. After the successfulimplementation of the CNG programme in Delhi, the Supreme Court identified 14polluted cities in two court orders (April 5, 2002, and August 14, 2003) forextension of its CNG drive.

Improved gas availability and waning infrastructure bottleneck toprovide the next leg of growth

The scarcity of natural gas in India vis--vis the huge gas demand from the corefertiliser and power sectors, and the inadequate pipeline infrastructure has

resulted in supply of gas to cities through distribution systems not developing inIndia as it did in several other countries (such as the UK, USA, Australia, Koreaetc). During CY2010, transport (CNG) and the residential segment constitutedmerely 2.8% of total gas consumed in India, compared to, say, 22% in the US.

But as the supply of gas improved (thanks to RILs KG D6 field and due to Indiasimproved ability to import LNG), and the natural gas pipeline grid expanded, moreand more Indian cities were able to get access to natural gas. Hence itsapplication in the residential and transportation sector is expected to grow.

According to the PNGRB (Petroleum and Natural Gas Regulatory Board), currentlythere are one million CNG vehicles in the country and this is expected to increaseto six million vehicles over the next 10 years. The PNGRB has laid down a target to

spread the CGD network across 200 cities with a potential gas demand of80mmcmd (million cubic meters per day) compared to the current consumption of14mmcmd in 25 cities.

Exhibit 1: Sectorwise gasconsumption breakdown

(%) Global India

Residentialand CNG

22.3 2.8

Commercial 14.4 1.2

Industrial 29.8 29.0Power 33.3 43.0

Fertilizer 24.0

Total 100 100

Source: BP Statistical review 2011


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The CGD supply chain in IndiaIn city gas distribution, gas flows to the end customer through various stages ofpressure reduction. Gas is supplied at low pressure to residential and commercialcustomers for cooking purposes as PNG via pressure reduction stations called IPRS(industrial pressure reduction) or DPRS (domestic pressure reduction). Gas is

supplied to cars as CNG wherein gas is compressed to a pressure of 200kg/cm2-

250kg/cm2- to enhance the storage capacity of cylinders mounted on cars.

Exhibit 2: CGD supply chain in India


Gas sources: Gas for the CGD business is sourced from a mix of gas produceddomestically and imported in the form of LNG. Domestic gas production meets~54% of CGD gas needs and is sourced mainly from ONGCs Bombay High, RILsKG D6 field, PMT (Panna-Mukta-Tapti), Ravva etc. LNG imports help meet thebalance gas demand for the CGD sector. PLNG accounts for 70% of LNG importedby India while the balance is imported by Shell, GAIL (Gas Authority of India Ltd)

and GSPC (Gujarat State Petroleum Corporation).

Gas transmission: About 75% of gas is transmitted by the state-ownedtransmission company, GAIL, with GSPL and RGTIL being the other players. Theyhelp to transmit the gas from the source of production/import to the cities via theirtrunk pipelines. Connectivity to large consumers (greater than 0.1mmcmd) isprovided by laying a spur pipeline from the trunk pipeline to the consumers plantwhile the small consumers (below 0.05mmcmd) are supplied via the CGD network.

CGD companies: The trunk pipeline feeds gas into the city gas distributionnetwork of CGD companies, which in turn supplies gas to small consumers (lessthan 0.05mmcmd) within cities like the household, commercial segment,automobile and small industrial sector. The key CGD companies are IGL, GGas

(Gujarat Gas), GAIL Gas, MGL, GSPC Gas, Sabarmati Gas, Adani Energy etc.

Exhibit 3: Usage of CGD

CGD consumers

Automobile in the formof CNG

Residential/commercialin the form of PNG

Small industries

UsageCNG as a transportationfuel

PNG is used for cooking,water heating etc

Gas is used forheating, cooling,power generation etc

Alternative fuelLiquid fuels like petrol anddiesel

Subsidised LPG cylinderand power

Liquid fuel (like fueloil, naphtha, diesel,etc), coal, power etc



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Exhibit 4: CGD value chain

Source: Ambit Capital research.

The bulk and Industrial segments comprise high volume customers and hence themargins earned from these customers are lower compared with the margin earnedon CNG, the domestic and commercial segments.

Although the volume consumed per customer is low in the PNG segment, giventhe huge potential consumer base, this segment has substantial volume growthpotential. Currently, the PNG segment generates low margins due to the highcapex requirement for setting up a PNG network. It costs anywhere between`15,000-`18,000 per household to lay a PNG pipeline but the provider can onlycharge: (a) ` 5,000 as refundable security deposit towards security of equipmentand installation used in providing last mile connectivity; and (b) `1,000 as securitydeposit towards PNG consumption bills.

CNG and the commercial segment are high margin businesses though the volumeofftake per customer is low. Given the low penetration of CNG in the autosegment (less than 10%), the growth potential is enormous.

Exhibit 5: Segmentwise volume v/s growth matrix

Source: GGas, Ambit Capital research


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Regulation of the CGD sectorThe PNGRB Act (Section 16) was notified in July 2010. This empowered the PNGRBto grant authorization to CGD companies to: (a) lay, build, operate or expandCGD networks via competitive bidding; (b) determine network tariffs for CGDnetworks and set a compression charge for CNG; and (c) have exclusivity for CGDnetworks. Prior to the PNGRB, the MoPNG (Ministry of Petroleum and Natural Gas)

had the power to authorize the setting up of CGD networks.

Exhibit 6: Indias existing CGD infrastructure

Source: Ambit Capital research.

Regulation for existing cities

As per MoPNG regulations, the network tariff and compression charge isdetermined so as to guarantee 14% RoCE (post-tax) on normative capitalemployed over a period of 25 years. The regulations for CGDs are along the samelines as in the case of the gas transmission pipeline business, except that the RoCEin the CGD business has been determined at 14% instead of 12% for the gastransmission businesses to account for the higher risk involved in the setting up ofa CGD business.

Exhibit 7: Regulation for existing CGD network

Note: LMC: Last Mile ConnectivitySource: GGas, Ambit Capital research

s per MoPNG regulations,end consumer price = cost ofgas + regulated transmissiontariff for trunk pipeline +regulated tariff for CGDnetwork + regulated chargefor CNG compression +unregulated marketing margin+ taxes and duties.

Network tariff for CGDnetwork and CNG compression

charge is determined on a DCFbasis, so as to guarantee 14%RoCE (post-tax) on normativecapital employed over a periodof 25 years.

Capital employed is equal to sum of gross fixed assets and working capital (equivalent of20 days of operating cost).


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Exhibit 8: CGD cost component

Cost componentalong the chain

Gas cost+ Trunk pipelinetransmissiontariff

+ CGDnetwork tariff

+ CNGcompression charge

+ Marketing margins

Regulated orunregulated

Unregulated Regulated Regulated Regulated Unregulated

Comments

Domestic APM gas

prices are regulatedwhile domestic non-APM gas price isapproved by theGovernment.

Tariff to guaranteepost-tax RoCE of12% on capitalemployed

Tariff to guaranteepost-tax RoCE of14% on capitalemployed

Compression chargebased on post-tax RoCEof 14% on capitalemployed

Compensation forsupply management, contract

negotiation, market tie-up,market surveys, disputeresolution, customer facilities,take or pay risk, bad debt risk,inventory carrying costs andmaintaining administrativeinfrastructure

Source: PNGRB, Ambit Capital research

Regulation for new cities

In contrast to the 14% assured RoCE in existing cities, for all CGD networks thatare awarded CGD contracts after the setting up of the PNRGB, the tariff isdetermined via competitive bidding. Hence there is no assured RoCE in these

cities (the RoCE is a function of the bids quoted in the competitive process).PNGRB regulations provide for marketing exclusivity of three years for companiesalready present in a city prior to the regulations and of five years, for thecompanies in new cities. It also provides for a network exclusivity of 25 years,extendable by another 10 years, if the operator fulfills service obligations andcomplies with service quality norms.

Exhibit 9: Bidding criteria for a new CGD network

Bidding criterion %weightage Comments

Lowness of the present value* of the unit networktariff

40(i) Network tariff to be quoted over 25 years of the economiclife of the network(ii) Entity to provide yearwise network tariffs in `/mmbtu

Lowness of the present value* of the CNGcompression charge

10(i) Compression charge to be quoted over 25 years of theeconomic life(ii) Entity to provide yearwise compression charge in `/kg

Highness of the present value* of the inch-kilometreof the steel pipelines

20

(i) Pipeline proposed to be laid during the marketing exclusivityperiod (i.e. 3 to 5 years)(ii) Entity to provide yearwise inch-km of steel pipelineproposed to be laid during the marketing exclusivity period

Highness of the present value* of the number ofdomestic customers to be connected

30

(i) Number of customers to be connected over the marketingexclusivity period (i.e. 3 to 5 years)(ii) Entity to provide yearwise number of customers proposed tobe connected during the marketing exclusivity period

Note 1: *Present value to be calculated using a discount rate of 14%


The CGD companies determine the final selling price of CNG/PNG by adding the

regulated network and compression charges to the cost of gas purchased. It alsoadds its marketing margin, which is currently not being regulated.

The factors that will determine the development of CGD ahead are:

A clear regulatory framework both for the entity responsible for the promotionof city gas distribution and regulation of existing players, and for the layout oftransmission pipelines across the country,

Sufficient gas supply via a mix of domestic gas and imported LNG, Fuel price reforms, and

Increased thrust on environmental regulation.

Key existing cities: Delhi,Mumbai, Ahmedabad,Pune, Surat, Hyderabad,Lucknow etc.

Key upcoming cities:Bhavnagar, Ludhiana,alandhar, Durgapur,

Panipat etc.


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Exhibit 10: Porter analysis of the CGD industry


Bargaining power of suppliersLOW

As the Government's gas utilization policy determinesthe quantum of domestic gas to be allocated to variousCGD companies and also has the final word on the gasprice, suppliers of domestically produced gas has little

bargaining power.

Due to shortage of domestic gas, all incrementalgrowth would have to be met via import of LNG. Butgiven the tightness in Asian LNG demand supplybalance and as LNG supply is concentrated with a fewbig deep pocketed players, LNG suppliers haverelatively superior bargaining power.

Bargaining power of buyersMEDIUM

The network tariff and compression charge is determined bythe regulator (a) to ensure guaranteed post-tax RoCE of 14%for existing cities; and (b) based on competitive bidding fornew cities. Hence buyers have no say on fixing the tariff.

As the cost of CNG is ~40%-50% lower than the cost ofpetrol and ~10%-20% lower than the cost of diesel, thedemand for CNG continues to be strong resulting insignificant discretionary conversion to CNG.

The cost of PNG ~5%-15% higher than the cost ofsubsidized LPG for households and significantly lower thanthe cost of LPG for the commercial segment. But theattractiveness of PNG is expected to improve as theGovernment plans to cap usage of subsidised LPG cylindersto 50% of current consumption (thereby increasing theaverage cost of LPG cylinders).

Gas is 11%-25% cost competitive vis--vis alternative liquidfuels (like naphtha, fuel oil) for the industrial segment.

Competitive intensityMEDIUM

In the existing cities, the competitive risk is mitigated to agreat extent by: (a) the regulated RoCE; and (b) the 5-yearmarketing and 25-year network exclusivity allowed by theregulator to the winning entity.

But in the new cities competition has intensified over last fewyears with establishment of the PNGRB-awarded competitive

bids, instead of the guaranteed returns in the pre-PNGRBera. PNGRB has announced plans to award bids for 200cities under competitive bidding. This has resulted inemergence of new players Adani, Essar, Lanco, OMCsetc.

Threat of substitutionLOW

CNG acts as a substitute to liquid fuels such as petrol/diesel inautomobiles. However, CNG is expected to continue to be costcompetitive given the: (a) Significant differential between thecost of CNG and the cost of petrol/diesel; and (b) Thederegulation of petrol and the proposed deregulation of dieselin a high crude price environment would help in maintainingthis differential.

PNG used by the household/commercial segment acts as asubstitute for subsidised LPG cylinders. Attractiveness of PNG isexpected to improve as the Government plans to restrict usageof subsidised LPG cylinders to only 4-6 p.a. per household, i.e.50% of actual consumption thereby increasing the average costof LPG cylinders.

Gas is used by the industrial segment as an alternative to liquidfuels like naphtha, fuel oil, diesel etc, and given the 11%-25%cost competitiveness of gas, we expect gas to substitute liquidfuel consumption in the industrial segment.

Barriers to entryMEDIUM

In existing cities, PNGRB allows 5-year marketingexclusivity and 25-year network exclusivity to the

winner of CGD network thereby creating highbarriers of entry for a new entrant in an existingcity.

Shortage of low cost domestic gas, huge capexrequirements, delays in land acquisition,environmental clearance, and increasingregulation will dis-incentivise the new playersfrom bidding for new cities.

The regulator gives due consideration to pasttrack record and technical expertise of the playerbefore awarding a CGD licence.

UnchangedImproving Deteriorating


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Sources of competitive advantage

The three key drivers for sustainable competitive advantage in the CGD sector are:

Gas sourcing ability, Pricing power, and Volume growth potential.(A) Gas sourcing ability

The ability to source gas at a competitive price is the key advantage for a CGDcompany, as it lowers the cost of gas sold by the company.

Exhibit 11: Government policy determines the key competitive advantage in gas sourcing

IGL GGas MGLGSPCGas

GAILGas

Comment

Existing domestic gasallocation

IGL and MGL have been allocated a higher proportion of domestic gas by the

Government due to their significant presence in the CNG and PNG segments.Decline in PMT gas production could lower the allocation for GGas.

Incremental domesticgas allocation

IGL and MGL enjoy a higher priority compared with other CGD companies forincremental allocation of domestic gas, as they sell almost ~90% of the gas tothe common man in the form of CNG or PNG while GGas sells only ~18% of its

volume to CNG/PNG segment.

LNG sourcing capability

IGL, MGL and GAIL Gas have superior ability to source LNG at competitiveprices given it is promoted by GAIL, who has significant presence in the businessof importing LNG. IGL gets LNG at a competitive price of US$9-US$12/mmbtucompared to the cost of US$13-US$15/mmbtu that most other players pay.Exitof BG Group could pose a threat to GGass ability to source LNG at competitiveprices.

Total

Source: IGL, GGas, Ambit Capital research.

Note: - Very Strong, - Strong, - Weak, - Very Weak

Gas can be sourced either domestically or via import in the form of LNG. As thecost of domestic gas is one-thirds the cost of LNG, allocation of domestic gas is abig plus for a CGD company.

Domestic gas is allocated to various sectors based on the Governments gasallocation policy. The Governments gas allocation policy accords low priority tothe CGD sector. The policy gives first priority to the existing customers in thefollowing order: fertiliser producers, LPG and petrochemicals, power plants, CGD,refineries and others. Once demand from existing customers is met, then the gaswould be allocated to greenfield projects based on the following priority: fertiliserproducers, petrochemicals, power plants, CGD and refineries.

Exhibit 12: RILs KG D6 gas allocation versus actual supply

Allocation (mmcmd)Sector

Firm Fallback TotalActual supply*

Power 32.7 12.0 44.7 20.0

Fertilizers 15.7 15.7 14.9

CGD 1.2 2.2 3.4 0.1

Sponge iron and steel 4.2 4.2 0.0

Refineries 5.0 6.0 11.0 0.0

Petrochemicals 1.9 1.9 0.4

LPG 2.6 2.6 2.6

Captive power 10.0 10.0 0.0

Total 63.3 30.2 93.5 38.0Source: MoPNG, Ambit Capital research, *during end January 2012


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Further, the domestic gas supply scenario has deteriorated over the past year dueto a significant decline in KG D6 gas production and due to the slow developmentof other key gas discoveries (thanks to delays in Government approvals, shortageof deepwater rigs and low domestic gas prices). Please refer to our note Is LNGthe answer to Indias energy needs? (December 7, 2011) for more details onthe prospects of domestic gas production.

Exhibit 13: Domestic gas supply growth will be low and back ended (mmcmd)FY10 FY11 FY12E FY13E FY14E FY15E Comments

Existingfields

86.3 80.8 81.7 84.9 85.8 86.6

Mature fields such as Mumbai High, PMT, Ravva to see agradual decline. Oil India's gas production in Assam to grow at4% p.a. due to an increase in demand.ONGC to produce 3-4mmcmd of gas from its marginal fields in FY13-FY14. ONGCis expected to produce ~25mmcmd of gas from its KG block,but the slowdown in progress due to the exit of its technologypartners is likely to push production to FY16-FY17.

RILs D6gas

39.2 55.5 45 50 50 60

Sub-surface issues resulted in current production from KG D6being half of the original expectation. RIL is currently studyingthe reservoir and expects ramp-up of gas production to bedelayed until CY14, as it needs a few years to drill additional

wells and connect it to the main reservoir.

RILsNEC gas

0 0 0 0 0 3

Slow progress due to delay in approvals for RILs other key gasblocks. This along with shortage of the deepwater rig and lowdomestic gas price has slowed the progress in its key gasblocks.

CBM gas 0 0.1 1 2 3 5CBM gas from Essar Oil's CBM blocks (under production) andfrom RIL's CBM blocks (from FY15 onwards).

GSPCgas

0 0 0 0 0 0

Due to delay in raising funds, we expect development work atDeen Dayal block to be slow. This could delay commissioning ofproduction to end FY15 or to FY16.As per the FDP, the totalcapex for Deen Dayal block is `85bn (up to now only`30bn hasbeen raised via term loans).

Total 125.5 136.5 127.7 136.9 138.8 154.6

Source: Infraline, RIL, ONGC, GSPC, OIL, Ambit Capital research

Hence although CGD has a priority over the industrial segment, the huge unmetdemand from the core fertilizer, LPG and power sectors and the bleak outlook ofdomestic gas production would result in no incremental gas allocation for theCGD sector for the next 2-3 years. In fact, the CGD sector runs the risk of afurther cut in the supply of gas from the KG D6 field. Although the CGD sector hasbeen allocated 3.4mmcmd of KG D6 gas (1.2mmcmd on a firm basis and2.2mmcmd on fallback basis), it is currently receiving less than 0.2mmcmd, andthat too runs a risk of being cut off completely.

Existing domestic gas allocation

CGD companies are likely to face a shortage of domestic gas and hence wouldhave to depend on the import of LNG to meet their growth requirements. SinceLNG is almost three times more expensive than domestic gas, using LNG wouldresult in an increase in the weighted average cost of gas.

Hence CGD companies with a higher proportion of domestic gas such as IGL (83%domestic gas in FY11) would have a competitive edge over others like GGas (68%domestic gas in FY11).


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Exhibit 14: Domestic gas allocation to the CGD sector (mmcmd)

APM allocationPMT

allocationRIL KG D6 allocation

Totalallocation

Entities Firm Fallback Total Firm Fallback Total

IGL: NCR 2.70 0.00 2.70 0.31 0.30 0.61 3.31

Gujarat Gas Company 0.29 0.17 0.46 2.13 0.60 0.60 3.19

MGL: Thane, Navi Mumbai 2.00 2.00 0.37 0.37 2.37

Bhagyanagar Gas Limited 0.10 0.10 0.15 0.37 0.52 0.62

MNGL: Pune 0.40 0.40 0.20 0.20 0.60

GAIL: Agra Firozabad 0.30 0.30 0.30

Sabarmati gas 0.08 0.15 0.23 0.23

Central U.P Gas Limited: Kanpur 0.10 0.10 0.10 0.10 0.20

Adani Energy Ltd. 0.20 0.20

TNGCL, Tripura 0.13 0.13 0.00 0.13

GAIL: Vadodara 0.13 0.13 0.13

Green Gas Limited: Lucknow 0.10 0.00 0.10 0.00 0.00 0.10

Vadodara Municipal Corporation 0.10 0.10 0.00 0.10

Green Gas Limited: Agra 0.04 0.00 0.04 0.02 0.01 0.03 0.07Central U.P Gas Limited: Bareilly 0.05 0.05 0.01 0.01 0.06

HPCL 0.05 0.05 0.05

GAIL Gas 0.00 0.02 0.02 0.02

Soumya DSM 0.02 0.02 0.02

AGCL 0.01 0.01 0.00

Total 5.92 0.27 6.19 2.13 1.23 2.17 3.40 11.72

Source: Infraline, IGL, GGas, Ambit Capital research

Exhibit 15: FY11 gas sourcing breakdown (mmcmd)

CGD entity Domestic gas

Domestic gas as a

percentage of totalconsumption

APM PMT KG-D6 Other

ImportedLNG

Total

APM Non-APM Total

LNG as % oftotalconsumption

Central UP Gas Ltd, Bareilly 0.05 NA NA NA 0.00 0.05 100 0 100 0Green Gas Limited: Lucknow 0.08 NA NA NA 0.00 0.08 100 0 100 0TNGCL, Tripura 0.03 NA NA 0.02 0.00 0.05 62 38 100 0Bhagyanagar Gas Limited 0.05 NA NA NA 0.00 0.05 100 0 100 0

AGCL 0.49NA NA 0.03 0.00 0.52 95 5 100 0 Vadodara Municipal Corp 0.10 NA NA NA 0.00 0.10 99 0 99 1Green Gas Limited: Agra 0.04 NA NA NA 0.00 0.04 98 0 98 2MGL: Thane, Navi Mumbai 1.40 NA 0.30 NA 0.10 1.80 78 17 94 6

HPCL NA NA 0.05 NA 0.01 0.06 0 91 91 9MNGL: Pune 0.04 NA NA NA 0.01 0.05 87 0 87 13Central UP Gas Ltd, Kanpur 0.10 NA NA NA 0.02 0.12 83 0 83 17IGL: NCR 2.12 NA 0.15 NA 0.47 2.74 78 5 83 17

Gujarat Gas Company 0.16 1.69 NA 0.44 1.07 3.36 5 63 68 32

Sabarmati Gas NA NA 0.07 NA 0.64 0.71 0 10 10 90GAIL Gas Limited, Dewas NA NA NA NA 0.03 0.03 0 0 0 100GAIL Gas Limited, Sonepat NA NA NA NA 0.01 0.01 0 0 0 100GSPC Gas NA NA NA NA 3.78 3.78 0 0 0 100Total 4.65 1.69 0.57 0.48 6.23 13.62 34 20 54 46

Source: Infraline, IGL, GGas, Ambit Capital research, Note: NA refers to Domestic gas Not Allocated by the Government


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Incremental domestic gas allocation

Furthermore, for any incremental allocation of domestic gas, the Governmentsintent and the Supreme Courts directive suggest that the Government gives higherpriority to the companies who sell a majority of their gas to the common maneither via CNG or PNG. This is also in the Governments interest as thesubstitution of: (a) Petrol/diesel by CNG; and (b) LPG by PNG would help theGovernment control its ballooning fuel subsidy burden.

As the commercial and industrial segments are unregulated, the Government doesnot want these two segments to enjoy the benefits of low-cost domestic gas.

Therefore we expect IGL to be preferred over GGas for additional allocation ofdomestic gas as ~91% of IGLs FY11 sales volume came from the CNG/householdPNG segment compared with ~18% for GGas in CY10.

LNG sourcing capabilities

CGD companies dependency on LNG will only increase going forward. LNG canbe sourced via long-term contracts (20-25 years), short-term contracts (2-3 years)or from the spot market. Given the huge price differential (10%-30%) between

LNG sourced from the above mentioned options and tightness in the Asian LNGdemand-supply balance, CGD companies will need to enter into strategic tie-upswith partners who import LNG.

IGL has a natural advantage over other players due to its strong parentage in theform of GAIL (a large importer of LNG into India). Currently IGL is getting0.44mmcmd of LNG from GAIL/BPCLs share of long term LNG supply fromRasGas, 0.25mmcmd of LNG from GAIL's 3-year contract with MarubeniCorporation while the remainder is sourced from the spot market.

With GAILs Dabhol terminal expected to commission by March 2012, IGL isbanking on GAIL for incremental short-to-medium term LNG contracts. Recently,GAIL has signed a 3.5mmtpa 20-year LNG supply agreement with the US-based

Cheniere Energys Sabine Pass LNG liquefaction terminal (18mmtpa capacity) from2017 onwards. This provides visibility on IGLs LNG sourcing capabilities.

GGas, on the other hand, is sourcing LNG via a mix of 2-3 year short termcontracts from BG group's global LNG portfolio and from the spot market. With theexit of BG, GGas will now have to enter into an agreement with a third party forsourcing of LNG. This could pose a challenge for GGas given tightness in theAsian LNG demand-supply balance. Further, it needs to enter into a long-termagreement (+10-year contract) for the supply of LNG to provide volume visibility versus its current dependence on the 2-3 year short-term contracts or spotcontracts.


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(B) Pricing power

Pricing power varies across CGD companies depending on the competitiveness ofits product (i.e. CNG, PNG) compared with alternative fuels. CNG is the mostcompetitive fuel given its huge (40%-50%) differential versus petrol prices;distributors with significant presence in the CNG business have better pricingpower.

Exhibit 16: Key determinants of pricing power

IGL GGas MGLGSPCGas

GAILGas

Comment

Statewise tax structurefor gas

Lower sales taxes/VAT on CGD in Delhi compared with the other states improvesthe relative attractiveness of the CGD business in NCR and gives IGL acompetitive advantage versus other CGD companies. High sales taxes/VAT onCGD in Gujarat, impacts the relative pricing power of GGas and GSPC gas.

Presence in high marginCNG business

The CNG segment is the most profitable given the 40%-50% differential with thecost of petrol. Further, deregulation of petrol price and the proposedderegulation of diesel price, would add to the cost competitiveness of CNG. As~80% of IGL and MGLs sales volume is dedicated to the CNG segment, theyhave better pricing power.

TotalSource: IGL, GGas, Ambit Capital research.


A presence in states with favourable tax policies

The sales tax/VAT on gas varies across Indian states for the CNG and PNGbusiness. While there is no sales tax/VAT applicable for CNG in the Delhi region(NCR), in other states this tax varies from 5%-15%, the highest being in Gujaratand Madhya Pradesh. A similar trend is visible in PNG as well. However, the variance in sales tax/VAT applicable across states is less pronounced in case ofpetrol/diesel/LPG.

Hence cost competitiveness of CNG and PNG is better in the NCR compared withother states. This serves as a competitive advantage for IGL over other CGDcompanies, strengthening its pricing power and providing high visibility on therising discretionary conversion from petrol to CNG vehicles.

Exhibit 17: Sales tax/VAT applicable for CNG v/s petrol/diesel and PNG v/s LPG across states

(%) NCR UP Gujarat Maharashtra Tripura Haryana MP Rajasthan

CNG segment CNG NIL 13.50 15.00 12.50 12.50 5.25 15.00 14.00

Petrol 20.00 26.55 25.46 27.85 20.00 21.00 30.04 28.90

Diesel 12.24 17.23 24.63 24.00 13.50 9.24 24.23 17.89

PNG segment PNG 5.00 26.00 15.00 12.50 12.50 12.50 14.00 5.00

LPG NIL NIL NIL NIL 1.50 NIL 5.00 NIL

Note: Some local authorities also impose taxes such as octroi on CNG and PNG. Note: UP stands for Uttar Pradesh, MP stands for Madhya PradeshSource: PPAC, Ambit Capital research

Key business segments

The CNG segment has the highest pricing power followed by the industrialsegment, while the PNG segment has the lowest pricing power. Usage of CNGresults in ~50% saving in running costs compared to petrol. Industrial consumersalso find it relatively easy to absorb the price hike as alternative liquid fuels are10%-30% more expensive than gas. But PNG is ~5%-15% more expensive thansubsidized LPG, and its cost competitiveness is subject to a gradual decline in the

LPG subsidy with the proposed capping of subsidized LPG cylinders.


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Further CNG/PNG customers are stickier in nature, compared to industrialcustomers, due to their limited flexibility to switch back to liquid fuels owing to theupfront cost incurred for CNG kit/PNG connectivity. On the other hand, theindustrial consumer always has the flexibility to revert to usage of liquid fuels giventhe dual fired nature of their plants.

(1) CNG: Strong pricing power

CNG prices in India are 40%-50% lower than the price of petrol due to: (a) Hightaxes on petrol compared to CNG see table below; and (b) The usage of low-costdomestic gas helps to reduce the price of CNG while the strength of internationalcrude prices is driving the price of deregulated petrol upwards.

Exhibit 18: High taxes on petrol boost CNGs cost competitiveness

`/litre Petrol DieselIndia (Delhi) 65.64 40.90

Pakistan 41.93 47.59

Bangladesh 45.53 27.57

Sri Lanka 50.75 34.69

Nepal 63.79 42.70Note: Price in India is as of Feb 22, 2012; prices for all other countries are as of July 2011

Source: PPAC, Ambit Capital research

Taxes constitute a high 41%-43% of the final price of petrol, although this variesacross states based on the variation in sales tax/VAT rates of the various states.Though the impact of taxes on diesel price is lower than that on petrol, it is stillhigh with taxes constituting 18%-25% of its final price. But taxes on CNG arelower: from 13% (in Delhi) to 28% (in Gujarat and Madhya Pradesh).

Exhibit 19: High taxes on petrol/diesel boost CNGs cost competitiveness

(%) Petrol Diesel CNG

DelhiTaxes as a % age of final price 41 18 13

-Central taxes (excise duty, customs duty) 18 7 13

-State taxes/VAT 23 11 NIL

Gujarat

Taxes as a % age of final price 43 25 28

-Central taxes (excise duty, customs duty) 16 6 13

-State taxes/VAT 27 19 15

Source: PPAC, Ambit Capital research

Hence as petrol prices are twice that of CNG, usage of CNG as a replacement forpetrol in 4-wheelers or 3-wheelers would result in ~50% reduction in fuel cost perkilometre. Even though there is an upfront cost of`25,000-`40,000 to be incurredfor installing the CNG kit, the cost can be recovered within 12-15 months if thedaily usage is 40km-50km. Similarly, CNG would result in ~18% saving in therunning cost per kilometre if it is used to replace diesel in a 4-wheeler or a bus see exhibits 20 and 21 on the next page.

The saving is lower in diesel compared to petrol due to: (a) Taxes on diesel beinglower; and (b) Regulation of the diesel price resulting in its price being `12-`13/litre lower than the market price. Note that the Government deregulatedpetrol prices with effect from June 25, 2010 while it announced its intention togradually deregulate diesel prices over time. This resulted in the petrol prices risingby 39% since the deregulation decision compared with a mere 7% increase in

diesel prices (while crude prices have risen by ~55% during this period).


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If the Government opts for diesel deregulation or even a `3-`4/litre hike in dieselprices post the ongoing state elections, it will further strengthen the pricing powerof CNG.

Exhibit 20: CNG cost competitiveness analysis (for Delhi)

Bus (CNG) 4 wheeler (CNG) 4 wheeler (CNG) 3 wheeler (CNG)

Cost of CNG kit (`) (A) 175,000 40,000 40,000 25,000

CNG price per kg (`) (B) 33.75 33.75 33.75 33.75

Mileage per kg (km) (C) 3.5 12 12 20

CNG cost per km (`) (D=B/C) 9.6 2.8 2.8 1.7Bus (diesel) 4 wheeler (diesel) 4 wheeler (petrol) 3 wheeler (petrol)

Cost of other fuel: (diesel for bus and 4 wheelerand petrol for 4 and 3 wheeler) (`/litre) (E) 40.91 40.91 65.64 65.64

Mileage (km per litre) (F) 3.5 12 12 20

Other fuel cost per km (`) (G=E/F) 11.7 3.4 5.5 3.3Saving per km from CNG (`) (H=G-D) 2.0 0.6 2.7 1.6CNG cost competitiveness (%) (I=H/G) 18 18 49 49

Daily average travel (km) (J) 150 40 40 50

Annual travel assuming 300 days (km) (K=J*300) 45,000 12,000 12,000 15,000

Yearly savings (`) (L=H*K) 92,057 7,160 31,890 23,918

Payback period (months) (M=A/L*12) 22.8 67.0 15.1 12.5

Breakeven (in km) (N=A/H) 85,545 67,039 15,052 15,679

Source: IGL, GGas, Ambit Capital research

Exhibit 21: CNG cost competitiveness analysis (for Gujarat)

Bus (CNG) 4 wheeler (CNG) 4 wheeler (CNG) 3 wheeler (CNG)

Cost of CNG kit (`) (A) 175,000 40,000 40,000 25,000

CNG price per kg (`) (B) 43.4 43.4 43.4 43.4

Mileage per kg (km) (C)3.5 12 12 20

CNG cost per km (`) (D=B/C) 12.4 3.6 3.6 2.2Bus (diesel) 4 wheeler (diesel) 4 wheeler (petrol) 3 wheeler (petrol)

Cost of other fuel: (diesel for bus and 4 wheelerand petrol for 4 and 3 wheeler) (`/ litre) (E) 46.3 46.3 70.0 70.0

Mileage (km per litre) (F) 3.5 12 12 20

Other fuel cost per km (`) (G=E/F) 13.2 3.9 5.8 3.5Saving per km from CNG (`) (H=G-D) 0.8 0.2 2.2 1.3CNG cost competitiveness (%) (I=H/G) 6 6 38 38

Daily average travel (km) (J) 150 40 40 50

Annual travel assuming 300 days (km) (K=J*300) 45,000 12,000 12,000 15,000

Yearly savings (`

) (L=H*K) 36,643 2,850 26,600 19,950Payback period (months) (M=A/L*12) 57.3 168.4 18.0 15.0

Breakeven (in km) (N=A/H) 214,912 168,421 18,045 18,797

Source: IGL, GGas, Ambit Capital research

Although a part of CNGs cost competitiveness is attributable to the allocation oflow-cost domestic gas, CNG will still sustain its competitiveness even if theproportion of LNG rises to 100% see exhibit 22 on the next page. Even if weassume 100% of the gas requirement is met via import of LNG, the price of CNGwould still be 19% lower than petrol.


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Exhibit 22: CNG cost competitiveness scenario analysis for IGL

Current gas mix Case 1 Case 2 Case 3

75% domestic gas+ 25% LNG



100% LNG

Weighted average gas cost (US$/mmbtu) 6.5 10.0 13.0 16.0

Gas cost (`/kg) 14.26 21.82 28.37 34.91

Operating expenses (including distribution,

compression and marketing) (`/kg)11.79 11.79 11.79 11.79

Basic selling price (`/kg) 26.05 33.61 40.16 46.70

Excise duty @ 14.42% (`/kg) 4.25 4.85 5.79 6.73

Vat @ 0% (`/kg) 0.00 0.00 0.00 0.00

CNG price (`/kg) 33.75 38.45 45.96 53.43Petrol price (`/litre) 65.64 65.64 65.64 65.64

CNG's cost competitiveness v/s petrol 49% 41% 30% 19%

Diesel price (`/litre) 40.91 40.91 40.91 40.91

CNG's cost competitiveness 18% 6% -12% -31%

Source: Infraline, Ambit Capital research

(2) Industrial segment: Medium pricing powerGiven the shortage of domestic gas and the fact that the industrial segment doesnot feature in the Governments priority list for allocation of domestic gas,incremental demand from the industrial segment will be met via LNG imports.However, even if we assume that 100% of the gas requirement for industrialconsumers is sourced from LNG imports, then too LNG would be competitive forindustrial consumers.

We estimate that even at a high 14.5% linkage to US$100/bbl of crude price, thedelivered cost of LNG would be US$17.8/mmbtu compared to US$20-US$22/mmbtu range for alternative liquid fuels. Thus the cost of gas will be 11%-25% lower than the prices of alternative liquid fuels see exhibit 23 below.

Exhibit 23: Gas cost competitiveness v/s liquid fuels for the industrial segment

LNG Fuel oil Naphtha Diesel

Brent crude price (US$/bbl) 100 100 100 100

Liquid fuel's average discount/premium to Brent (%) -15 -1 10

Implied f.o.b. fuel price (US$/mmbtu for LNG andUS$/bbl for liquid fuels)

14.5 85.0 99.0 110.0

Add: Transportation, taxes and duties, processing,marketing and other costs (US$/mmbtu for LNG andUS$/bbl for liquid fuels)

3.2 17.0 19.8 16.5

Implied delivered price to the end-consumer postadjustment for subsidy on diesel (US$/mmbtu for LNGand US$/bbl for liquid fuels)

17.7 102.0 118.8 120.2

Implied f.o.b. fuel price adjusting for dieselsubsidy (US$/mmbtu)

17.7 19.6 20.7 22.1

LNG's discount to liquid fuels (%) 11 17 25

Source: Bloomberg, Ambit Capital research

Exhibit 24 shows the historical comparison of gas costs (based on LNG imports)with the prices of fuel oil, naphtha and diesel in US$/mmbtu terms. Clearly, LNGprices have been 10%-20% lower than prices of alternative liquid fuel.


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Exhibit 24: LNGs cost competitiveness v/s liquid fuel

0

5

10

15

20

25

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12

Fuel oil

Naphtha

Brent

LNGDiesel

(US$/mmbtu)


(3) PNG: Pricing power subject to capping of LPG subsidy

Even though PNG is slightly more expensive than subsidized LPG, it is stillattractive given that PNG is easily accessible and helps to meet the huge demandfor reliable and continuous supply of cooking gas.

Currently the Government provides LPG to all families at ~`400/cylinder (of14.2kg) against a market price of `750/cylinder. Hence the cost of PNG ismarginally higher (1%-15%) versus the cost of LPG.

Exhibit 25: Cost competitiveness: PNG v/s LPG

IGL GGas

Cost of the domestic LPG cylinder of 14.2kg (`) 399 402

Cost per kg of LPG (`) 28.1 28.3

PNG selling price per kg (`

) 32.2 28.5Price advantage over LPG (`/kg) -4.1 -0.2

Price advantage over LPG (%) -14 -1


However, it is worth noting that LPG prices in India are very low (~50%) comparedto prices prevailing in other countries see exhibit 26 below. Hence theGovernment is considering capping the number of subsidized LPG cylinders at 5-6cylinders p.a. per household against the average annual consumption per familyof 11-12 cylinders. This would drive up the average cost of LPG to ~`-`500-550/cylinder thereby improving the competitiveness of PNG. Considering the hugeLPG user base and the Governments intention to phase out the subsidy on LPG,there is a huge growth potential for gas consumption in the PNG segment.

Exhibit 26: LPG price comparison

Country LPG (`/14.2kg cylinder)India (Delhi) 399

Pakistan 606

Bangladesh 474

Sri Lanka 872

Nepal 827

Source: PPAC, Price in India is as of 10 th Feb 2012, all other countries prices are as of July 2011


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(C) Volume growth potential

The scarcity of natural gas and the inadequate pipeline infrastructure has led toslower ramp-up of gas supply through the city distribution network in Indiacompared to other countries. But as the supply of gas has been improving and asthe countrys gas pipeline grid is expanding, more Indian cities should get accessto natural gas going forward.

PNGRB has laid down a target to spread the CGD network across 200 cities withpotential gas demand of 80mmcmd (current consumption: 14mmcmd from 25cities). The aim is to have a CGD network in all cities with population above 2.5mnand then to expand to cities with a population between 1mn and 2.5mn.

Of India's total population of 1.2 billion, ~30% stay in cities with greater than 1mnpopulation. These cities can be connected with the city gas network within the next10 years. If even 75% of the above stated segment gets connected with gasinfrastructure, it would mean a potential consumer base of 270mn. The globalaverage per capita gas consumption (for CNG and PNG) is 0.1scmd, implying apotential demand of 27mmcmd for residential use. In addition, based on potentialliquid fuel consumption in the industrial segment that can be substituted with gas,the requirement of small scale industries is estimated as 28mmcmd. Hence

gasconsumption in the CGD segment is likely to grow from ~14mmcmdcurrently to 55mmcmd over the next 10 years.

Hence, companies with a licence to operate in cities with high potential gasdemand, will have a competitive edge. Further, as CNG is the most competitivesegment, companies with significant exposure to CNG are better placed.

Exhibit 27: Driver of competitive advantage in volume growth potential

IGL GGas MGLGSPCGas

GAILGas

Comment

Presence in high growth

cities

Exclusive CGD licence for high-growth cities (like NCR/Mumbai) gives thecompany (like IGL/MGL) a first mover advantage to capture the hugeopportunity before the exclusivity period ends. A presence in the high growth

NCR market along with Supreme Court order to convert all public vehicles toCNG in NCR, puts IGL in a sweet spot.

Presence in high growthpotential CNG andPNG business

The CNG and PNG segments have the highest growth potential versus theindustrial segment as penetration of CNG/PNG is less than10%. As ~90% of IGLand MGLs sales volume is to the CNG/PNG segment, they are better placed totap this growth opportunity.

Sub-total

Source: IGL, GGas, Ambit Capital research.


Presence in high growth cities

As can be seen from exhibit 28 below, the potential for gas demand in cities varies

depending on its population, stage of economic growth, trunk pipelineconnectivity, any regulatory push for switching over to gas, any tax benefit for CGDcompanies etc.

Given the volume growth potential, the NCR is among the prime markets for theCGD business, although a significant part of its growth is attributable to theSupreme Courts July 1998 order to convert all buses, three-wheelers and taxis inDelhi to adopt CNG as a fuel by March 31, 2001.

Hence we expect IGL to see 16% volume CAGR over next 3-4 years from itsexisting cities given the competitiveness of its CNG business and the lowpenetration currently of CNG and PNG in the NCR.


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Exhibit 28: Demand potential of existing CGD network (mmcmd)

CGD companies CGD licenceFY11sales

Potentialdemand in

FY15*

IGLDelhi, Noida, Greater Noida, Faridabad& Ghaziabad

2.74 5.21

Gujarat Gas Surat, Bharuch and Ankleshwar 3.36 4.13

GSPC Gas Rajkot and many other districts 3.78 5.40

MGL Mumbai 1.80 3.20

Sabarmati Gas Gandhinagar, Mehsana & Sabarkantha 0.71 1.20

Maharashtra Natural Gas Pune 0.05 0.81

Bhagyanagar Gas Ltd.Hyderabad, Vijaywada, Rajahmundry andKakinada

0.05 2.20

GAIL Gas Ltd. Dewas, Kota, Sonepat and Meerut 0.05 1.10

Source: Infraline, Ambit Capital research *Ambit Capital research estimate

To accelerate deployment of the CGD network, PNGRB had invited bids in 2009for 13 cities in two rounds. The bidding process for the third round got delayeddue to inability of the PNGRB to issue the CGD licences see callout on the left.However, thanks to the Supreme Courts May 2011 decision, PNGRB can now

process all pending CGD licence allocations and the winners are expected to beannounced by March 2012.

The fourth round of bidding has been cancelled by the PNGRB owing to aggressivebidding by the companies (which has resulted in companies quoting low bidsmaking the project appear unviable and raising doubts about its actual execution).

Exhibit 29: Completed CGD bidding rounds

Bidding round City StateWinners of 1st and 2nd bidding rounds and Bidders of the 3 rdround

Devas Madhya Pradesh GAIL

Kakinada Andhra Pradesh Bhagyanagar Gas (JV of GAIL/HPCL)

Kota Rajasthan GAILMeerut Uttar Pradesh GAIL

Sonepat Haryana GAIL

1st biddinground:March 2009

Mathura Uttar Pradesh DSM Infratech

Rajahmundry, Yanam Andhra Pradesh RIL

Sehdol Madhya Pradesh RIL

Chandigarh Haryana Adani Energy/IOC

Allahabad Uttar Pradesh Adani Energy/IOC

Ghaziabad Uttar Pradesh IGL

2nd biddinground:June 2009

Jhansi Uttar Pradesh Central UP Gas Limited

Asansol West Bengal HPCL, GAIL Gas, Great Eastern Energy., Essar Projects Ltd, etc

Bhavnagar Gujarat GSPC Gas, Gujarat Gas

Kutch East Gujarat HPCL, GAIL Gas, GSPC Gas, Adani Gas, PSL Gas Distribution etc

Kutch West Gujarat JSIW Infrastructure, GSPC Gas, Adani Gas, PSL Gas Distribution etcJamnagar Gujarat GSPC Gas, Lanco Infratech Ltd.

3rd biddinground: Biddingconcluded in Feb2011and awardannouncement islikely by Mar 2012

Jalandhar, Ludhiana Punjab HPCL, IGL, GAIL Gas, IOCL/Adani, BPCL/ONGC/OIL, GSPL/GSPC.Rangareddy, Medak,Khammam, Nalgonda

Andhra Pradesh

Ernakulam Kerala

Guna Madhya Pradesh

Alibag, Lonavla/Khopoli Maharashtra

4th biddinground: these bidshave been cancelled

Shahjahanpur Uttar Pradesh

Bidding was initiated in Oct 2010 but has been has been cancelledby PNGRB.


lthough the PNGRB wasconstituted in 2006, it was notable to issue even a single

CGD licence as the Delhi HighCourt (via its January 21, 2010order) questioned the PNGRBs

power to issue authorisation forCGD projects since theGovernment had not notified

Section 16 of the PNGRB Act,(Section 16 gives PNGRB the

powers to grant CGD licences). Section 16 was finally notifiedby the Government in July

2010 and the Supreme Court

gave its decision in May 2011in favour of the PNGRB therebyallowing it to process all

pending applications for thegrant of CGD licences.


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Presence in the high-growth potential CNG and PNG business

Due to the scarcity of natural gas and the inadequate pipeline infrastructure, thetransport (CNG) and the residential segments in cities constituted only 2.8% of thetotal gas consumed in India in CY10 compared with, say, 22% in the US. But now,as the supply of gas has improved (thanks to RILs KG D6 field and due to Indiasimproved ability to import LNG), and as the natural gas pipeline grid expanded,more Indian cities were able to gain access to natural gas. Hence its application in

the residential and transportation sectors is expected to increase going forward.

Exhibit 30: US CY10 gas consumption breakdown

Fertilizer,

0%

Power,

33.3%

Industrial,

29.8%

Commercial, 14.4%

Residential

and CNG,

22.3%

Source: EIA, Ambit Capital research

Exhibit 31: Indian CY10 gas consumption breakdown

Fertilizer,

24.0%

Power,

43.0%

Industrial,

29.0%

Commerci

al, 1.2%Residential

and CNG,

2.8%


As at end-FY11, there were 1.1mn CNG vehicles and the PNGRB expects thisnumber to increase to 6mn vehicles over the next 10 years. As is evident from theexhibit 32 below, more than 40% of the CNG vehicles are from the NCR region.

This is driven by a mix of regulatory push (Supreme Court order) and favourabletax breaks for CNG in Delhi. As IGL holds the licence for the CGD business inDelhi and NCR, it is well placed to capture this huge market.

Exhibit 32: Breakdown of statewise CNG vehicles (in 000)

State Cars/Taxies Autos Buses Others Total

NCR 282 122 17 11 432

Gujarat 133 196 4 4 337

Maharashtra 68 154 4 3 229

Uttar Pradesh 2 21 2 9 33

Haryana 22 4 0 1 27

Andhra Pradesh 1 7 0 08Madhya Pradesh 2 4 0 0 6

Tripura 0 2 0 0 2

Total 510 508 28 27 1,074


To support volume growth, IGL plans to invest `28bn over FY12E-FY16E toincrease the number of CNG stations and to provide a PNG network to all itsgeographical areas, so as to capture the full potential of its existing cities. IGL hasconsistently increased the number of CNG stations from 181 in FY09 to 278stations by the end of FY11; with 40 of these stations to start operations by June2012 (they are awaiting statutory clearance). Further IGL is constructing another

20-30 CNG stations, of which ~20 stations are expected to be commissioned inFY13.


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We see IGL as the best CGD playWe prefer IGL over GGAS based on: (a) High allocation of domestic gas due to itsexposure to Government preferred CNG/PNG business and efficient sourcing ofLNG given its strong parentage, (b) Pricing power which is underpinned by itssignificant presence in the competitive CNG segment and the favourable tax

treatment for CGD in the NCR; and (c) Strong volume growth potential due to itsexclusive licence for setting up a CGD network in the huge NCR market plus itspresence in underpenetrated and Government preferred CNG/PNG business.

Higher mix of domestic gas

As discussed above, the high allocation of domestic gas is the biggest competitiveadvantage for IGL as it met 83% of its current gas requirement compared to ~68%for GGas and the average of ~54% for other CGD companies.

The Government has allocated 2.7mmcmd of domestic APM gas to IGL for its NCRoperations and has allowed it to use unutilised APM allocations forGhaziabad/Faridabad CGD for its Delhi CGD. Further IGL has been allocated APM

gas, priced at US$4.2/mmbtu, compared with GGas which has been allocatedPMT gas, priced at US$5.7/mmbtu. Moreover production from the PMT field is ona declining phase and hence GGas faces the risk of a decline in its PMT allocation.

Exhibit 35: IGL gas sourcing mix (mmcmd)

AllocationActual

supply*

APM gas for:

Delhi 2.00 2.00

Noida/Greater Noida 0.20 0.20

Ghaziabad 0.25 0.25

Faridabad 0.25 0.25

Total APM gas (A) 2.70 2.70

RIL KG D6 gas (0.31 on firm basis and 0.30 on fallback basis) (B) 0.61 0.05

Total Domestic gas (C=A+B) 3.31 2.75

LNG (D) 0.74

Total (E=C+D) 3.49

Source: IGL, Ambit Capital research ... *for FY12

But for GGas, the decline in supply from the matured PMT field and lack ofadditional domestic gas allocation would result in its entire volume growth beingmet via import of LNG. The share of LNG in its gas mix during CY11 stood at ahigh 38%. Though GGas has been allocated 0.6mmcmd from the KG D6 block ona fallback basis, gas supply is not expected to commence unless KG D6 gas

production exceeds ~75mmcmd (against current production of ~39mmcmd), thelikelihood of which appears limited over the next 3-4 years given the reservoirchallenge being faced by the operator.

Exhibit 36: GGas gas sourcing mix (mmcmd)

AllocationActual

supply*

Domestic gas:

PMT, APM, Niko and Cairn Lakshmi field 2.83 2.20

RIL KG D6 (0.61on fallback basis) 0.61 0.00

Total domestic gas (A) 3.44 2.20

LNG (B) 1.31Total (C=A+B) 3.51

Source: GGas, Ambit Capital research ... *for CY11

The Government had allocated0.5mmcmd forGhaziabad/Faridabad CGD

projects, but the actualconsumption in these regions

stood at only ~0.2mmcmd,resulting in IGL not being ableto utilize the balance~0.3mmcmd of APM gasallocation. In June 2011, theGovernment allowed it to usethe excess APM gas availablefor its Delhi CGD wheredemand was higher than the

PM allocation of 2mmcmd.


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Though the share of LNG in IGL will also grow to ~48% of its gas mix in FY15,similar to GGas, it is due to the higher volume CAGR of 15% expected in IGL overthe next 3-4 years compared to the 4%-5% volume CAGR expectation for GGas.

Exhibit 37: IGL: Domestic gas dominates the gas mix

43% 47%33%

21%14%3% 8%0%

20%

40%

60%

80%

100%

FY09

FY10

FY11

FY12e

FY13e

FY14e

FY15e

LNG Domestic gas

Source: IGL, Ambit Capital research

Exhibit 38: GGas: LNG acquires major share of gas mix

8% 13%26%

37% 41%45% 48%

0%

20%

40%

60%

80%

100%

CY08

CY09

CY10

CY11e

CY12e

CY13e

CY14e

LNG Domestic Gas


Higher priority for allocation of additional domestic gas

IGL would be preferred over GGas for the additional allocation of domestic gas as~91% of the IGL sales volume arises from CNG/household PNG segmentscompared with ~18% for GGas. This is also evident in the KG D6 allocation,where IGL has been allocated 0.31mmcmd on a firm basis and 0.3mmcmd on afallback basis, while GGas was allocated 0.6mmcmd entirely on a fallback basis.

Exhibit 39: IGL: CNG will continue to dominate its salesmix

92% 89% 82% 78% 75% 72% 70%

4% 6% 9% 11% 12% 14% 15%

0%

20%

40%

60%

80%

100%

FY09

FY10

FY11

FY12e

FY13e

FY14e

FY15e

CNG PNG Industrial


Exhibit 40: GGas: Industrials to continue to lead salesmix

8% 10% 10% 11% 12% 13% 14%

72% 81% 83% 82% 80% 79% 77%

0%

20%

40%

60%

80%

100%

CY08

CY09

CY10

CY11e

CY12e

CY13e

CY14e

CNG PNG Industrial


Strong parentage helps IGL with LNG sourcing

As discussed above, IGLs strong parentage in the form of GAIL gives it acompetitive edge for the efficient sourcing of LNG. But on the other hand, therecent decision of the BG Group to sell its stake in GGas would raise a question onGGass ability to source LNG. Further, GGass high dependence on LNG imported

via spot contracts doesnt provide volume visibility and makes them vulnerable toprice volatility of spot LNG.


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Strong pricing power

As discussed in detail in the preceding pages, IGL has strong pricing power drivenby:

Favourable taxation for CNG in the NCR strengthening its competitivepositioning

Higher proportion of domestic gas High exposure to the competitive CNG business.In contrast, GGas will continue to face pressure on its margins due to the growingproportion of high-cost LNG in its gas mix. Moreover, the cost of LNG is higher forGGas due to its high dependence on LNG imports via spot contracts.

Better growth prospects for IGL

IGLs growth prospects lie in its exclusive licence to distribute gas within theextensive NCR market. The Supreme Courts regulation forcing compulsory usageof CNG in public commercial vehicles in the NCR region fuelled its volume growthover the last decade. We expect the growth momentum in the current decade tocome from private vehicle conversions going forward driven by the attractiveeconomics versus petrol, along with the launch of several CNG-fitted vehicles bycar manufacturers.

We expect IGL to see 16% volume CAGR over the next 3-4 years from its existingcities given the competitiveness of its CNG business and given the low penetrationof CNG and PNG segments.

Delhi has a total vehicular population of approximately 5mn; of which only~0.46mn operate on CNG. Thus, even after a decade since its introduction, theCNG penetration, at less than 10% is still very low.

The 35% increase in petrol prices since the deregulation of petrol in June 2010 has

widened the differential between CNG and petrol price pushing up thediscretionary conversion of private vehicles to CNG to 5,000 cars/month comparedwith 3,000 cars/month last year. We expect the pace of car conversion rate toaccelerate further as diesel prices are expected to rise due to its proposedderegulation. The importance of the private car segment can be appreciated fromthe fact that cars/taxis comprised almost two-thirds the total CNG vehicles in theNCR, of which ~90% is private cars and the balance is taxis.

Exhibit 41: CNG vehicles growth trend (in 000)

FY07 FY08 FY09 FY10 FY11 FY11 mix FY07-11 CAGR

Cars/Taxi 48 130 175 213 282 65.3% 56%

Auto 68 80 93 107 122 28.2% 15%

Buses 12 12 13 14 17 3.9% 10%

Rural transport vehicle 5 6 6 6 11 2.6% 20%

Total 133 228 287 340 431 100% 34%


To support volume growth, IGL is putting in place measures to significantlyenhance and expand infrastructure. IGL has consistently increased the number ofCNG stations from 181 in FY09 to 278 stations by the end of FY11, with 40 ofthese stations to start operations by June 2012, as they are awaiting clearancefrom the fire and explosives department. Further, IGL is constructing 20-30 CNGstations, of which ~ 20 stations are expected to be commissioned in FY13.

IGL plans to invest `28bn over FY12E-FY16E to increase the number of CNGstations, provide a PNG network to all its geographical areas and connect to asmany industrial consumers so as to capture the full potential of its existing cities.


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Oil & Gas


Exhibit 42: IGLs capex plan on a growing spree

0

1

2

34

5

6

7

8

9

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12e

FY13e

FY14e

FY15e

Heavy capex phase


In contrast, for GGas the volume CAGR would be capped at 4%-5% as its growth isprimarily dependent on the saturated Industrial segment demand. It is to be notedthat industries in Gujarat have been well served with gas for the last couple ofdecades due to its proximity to the source of gas supply and pipeline connectivity,thus the demand growth from this segment would be only 3%-4% p.a.

GGas plans to incur capex of approximately`1.5bn p.a. over the next three yearsfor expansion within its existing operational area. Further the company has bid forBhavnagar (potential demand of ~1mmcmd) to support its future growthprospects. If it were to win the bid for Bhavnagar, then it would requireincremental capex of`1.0bn to 1.2bn annually for the first five years.

Exhibit 43: IGL: Volume growth to continue to be robust

0.0

1.0

2.0

3.0

4.0

5.0

6.0

FY09

FY10

FY11

FY12e

FY13e

FY14e

FY15e

0%

5%

10%

15%

20%

25%

30%

Sales volume (mmcmd) Growth (Y-o-Y)


Exhibit 44: GGas: Volume growth stagnating at 4%-5%

0.0

1.0

2.0

3.0

4.0

5.0

6.0

CY08

CY09

CY10

CY11e

CY12e

CY13e

CY14e

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

Sales volume (mmcmd) Growth (Y-o-Y)


Relative valuation

At the current market price:

IGL is trading at: (a) 1-year forward EV/EBITDA of 8.1x, 25% higher than itsown 5-year average multiple of 6.5x; (b) 1-year forward PE of 14.5x, 24%higher than its 5-year average multiple of 11.7x; and (c) 1-year forward PB of3.5x, 17% higher than its 5-year average multiple of 3.0x.

GGas is trading at: (a) 1-year forward EV/EBITDA of 10.3x, 24% higher thanits own 5-year average multiple of 8.3x; (b) 1-year forward PE of 15.6x, 28%

higher than its 5-year average multiple of 12.2x; and (c) 1-year forward PB of4.8x, 41% higher than its 5-year average multiple of 3.4x.


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The comparison to the 5-year average multiple makes IGL look expensive.However, IGL was trading at low valuations before June 25, 2010 due to concernson its pricing power as petrol prices were regulated impacting the competitivenessof CNG. But since the deregulation of petrol prices on June 25, 2010, the stockhas traded at a 1-year forward PE of 15.8, 1-year forward PB of 4.1x and 1-yearforward EV/EBITDA of 8.9x.

Hence post June 25, 2010 we note the following improvements in IGLs

fundamentals: (i) Cost competitiveness of CNG improved due to deregulation ofpetrol price amid high crude prices; (ii) Allocation of additional APM gas to IGL forexpansion into NCR lowered its gas cost; and (iii) There was increasing evidenceof IGLs pricing power, as it managed to pass on the increase in gas cost by raisingCNG prices by over 20% in the last one year.

GGas is trading at a PE multiple in line with IGL. But GGas trades at 15% premiumto IGL on the PB and EV/EBITDA multiples despite its volume growth stagnating at~5% and resulting in muted earnings growth of 4.4% over CY11-CY14E. This isdespite its pricing power being under risk due to its higher dependence on LNG.

Exhibit 45: IGL 1-year forward PE band (`)

9x

12x

15x

17x

7x

0

100

200

300

400

500

Feb-06 Feb-08 Feb-10 Feb-12


Exhibit 46: GGas 1-year forward PE band ( )

7x

12x

15x

17x

9x

0

100

200

300

400

500



Exhibit 47: IGL 1-year forward PB band (`)

1x

2x

3x

4x

5x

0

100

200

300

400

500



Exhibit 48: GGas 1-year forward PB band (`)

1x

2x

3x

4x

5x

0

100

200

300

400

500




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Oil & Gas


IGL is trading at 15.4x FY13 consensus EPS, a 10% discount versus global peersand at the lower end of 15x-20x, at which most Asian peers are trading. This isdespite its: (a) superior RoCE of +20%; and (b) strong earnings growth of 12%CAGR over FY11-FY14E. GGas also trades at a similar multiple as IGL despite its volume growth stagnating at ~5% resulting in muted earnings growth of 4.4%during CY11-14E.

Exhibit 49: Global gas utilities valuation table

EV/EBITDA (x) P/E (x) P/B (x) EBITDA margin (%) RoE (%)

CompanyFY12/CY11

FY13/CY12

FY12/CY11

FY13/CY12

FY12/CY11

FY13/CY12

FY12/CY11

FY13/CY12

FY12/CY11

FY13/CY12

US Peers

Energy Transfer Partners LP 10.0 8.7 24.1 19.2 1.8 1.9 25.3 26.7 7.8 7.2

El Paso Corp 12.8 10.8 26.4 22.4 4.2 3.5 56.7 63.7 10.8 17.8

Nustar Energy 12.4 11.0 19.8 17.0 1.5 1.6 8.4 8.8 8.8 9.4

Oneok Partners 13.1 11.7 20.2 20.7 2.9 2.8 10.4 13.7 17.9 17.4

Boardwalk Pipeline LP 12.5 11.6 20.1 18.3 1.6 1.6 58.2 59.0 8.3 9.7

Enbridge Energy 12.4 11.5 23.8 21.9 2.3 2.3 12.5 13.2 11.4 11.6

Kinder Morgan Energy 10.9 9.7 37.8 33.9 3.9 3.9 40.3 40.9 10.3 12.5

EQT Corp 8.5 6.8 23.1 16.9 2.1 1.9 71.0 72.3 9.8 13.5

Nisource 9.0 8.5 16.6 15.9 1.3 1.3 26.3 27.6 8.2 8.4National Fuel Gas 7.2 6.0 18.4 16.4 2.0 1.9 39.4 40.9 11.2 12.5

Energen Corp 5.9 5.0 15.3 11.9 1.4 1.3 53.3 55.4 10.8 12.8

Southern Union 11.4 10.6 23.1 21.6 2.0 1.9 30.7 34.1 9.0 9.8

Piedmont Natural Gas 10.2 9.6 20.4 19.0 2.5 2.3 22.3 22.8 12.0 11.8

Vectren Corporation 7.0 6.5 15.9 15.0 1.6 1.6 24.3 24.6 10.3 10.6

Spectra Energy Partners 10.4 9.9 16.2 15.4 2.3 2.1 53.9 53.4 14.5 14.6

APA group 3.6 3.3 9.0 7.8 1.3 1.1 72.8 71.9 15.4 15.0

Enterprise Products Partners LP 15.0 14.0 22.4 20.7 4.0 4.1 8.9 8.9 17.8 19.0

Magellan Midstream Partners LP 15.0 13.8 18.9 17.3 5.1 4.9 35.4 36.5 27.5 28.6

US peers average 10.4 9.4 20.6 18.4 2.4 2.3 36.1 37.5 12.3 13.5

European Peers

Enagas 7.4 6.8 9.3 8.7 1.7 1.6 78.6 79.0 18.3 17.9

Snam Rete Gas 5.7 5.9 17.4 11.0 0.8 0.8 18.8 19.1 5.5 7.1European peers average 6.5 6.3 13.3 9.9 1.3 1.2 48.7 49.1 11.9 12.5

Asian peers

Hong Kong & China Gas 25.2 22.5 25.0 23.0 3.7 3.4 31.5 31.0 14.9 14.4

ENN Energy 9.8 8.6 17.5 14.4 3.1 2.6 20.4 19.1 18.8 19.5

Towngas China 18.7 15.7 19.1 15.3 1.2 1.1 18.3 17.2 6.5 7.6

China Resources Gas 9.8 7.9 18.6 15.2 2.9 2.5 20.2 18.7 16.9 16.9

China Gas 9.7 8.6 17.5 15.1 1.7 1.5 14.9 13.7 10.3 11.0

Beijing Enterprises 13.4 11.6 19.5 16.6 1.5 1.4 16.1 15.8 8.1 9.0

Petronas Gas BHD 11.5 10.7 21.3 19.4 3.5 3.3 72.3 72.6 17.4 17.2

GAIL 7.7 6.9 11.8 11.1 2.0 1.8 17.3 17.4 18.2 17.3

GSPL 5.4 5.3 9.0 8.8 1.9 1.6 91.9 92.0 33.3 27.1

PETRONET 8.7 7.9 12.2 12.0 3.7 3.0 8.9 7.8 33.3 27.1

IGL 8.6 7.3 16.3 14.6 3.9 3.3 24.8 21.6 26.5 24.4GUJARAT GAS CO 10.4 9.3 15.8 14.3 4.9 4.1 20.1 18.8 32.0 30.6

Asian peers average 11.6 10.2 17.0 15.0 2.8 2.5 29.7 28.8 19.7 18.5

Global peers average 10.6 9.5 18.8 16.6 2.5 2.3 34.5 34.9 15.1 15.3

Global peers median 10.1 9.0 18.7 16.1 2.1 1.9 25.0 25.7 11.7 14.0

Source: Bloomberg, Ambit Capital research.


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Marketing margin regulation impact?

The CGD companies determine the final selling price of CNG/PNG by adding theregulated network and compression charges to the cost of gas purchased. It alsoadds its marketing margin, which is currently not being regulated. The networktariff and compression charge is determined by the regulator so as to guarantee

14% RoCE (post-tax) on normative capital employed over a period of 25 years. Butmarketing margins are negotiated between buyers and sellers.

Marketing margin is paid to CGD companies for undertaking supplymanagement, contract negotiation, marketing tie-up, market surveys, disputeresolution, customer facilities, inventory carrying costs and maintainingadministrative infrastructure. It is also a compensation for the take-or-pay risk andthe bad debt risk that the company bears.

In January 2012, the Government asked the regulator, PNGRB, to examine themarketing margin charged by all marketers and fix it on the basis of costs incurredin the marketing of gas. This resulted in a ~10% decline in the stock price of CGDcompanies on fears of a steep cut in marketing margin post its regulation.

To study the possible implication of the marketing margin on earnings, webifurcated IGLs current CNG and PNG realization - see exhibit 50 below. Ouranalysis shows that that IGL earns ~`0.45/scm on CNG and ~`0.14/scm on PNGas the marketing margin.

Exhibit 50: Impact of marketing margin on IGL

CNG (`/scm) PNG (`/scm)Consumer price (A) 26.06 16.92

Excise duty (B=14.42% of C) 3.28 2.13

Net Selling Price (C) 22.78 14.79

Gas cost (D) 13.69 11.15

Network charges* (E) 3.50 3.50

Compression charges* (F) 5.13 0.00

Marketing margin (G=C-D-E-F) 0.45 0.14

IGLs FY11 PAT in `/scm (H) 2.6 2.6

Marketing margin as a % of FY11 PAT (I=G/H) 17.5% 5.2%

*Levelised network tariff and compression charge submitted by IGL management to PNGRB so as to ensurethe regulated post tax RoCE of 14% on capital employed. It is yet to be approved by the regulator.


Hence the marketing margin constitutes ~17.5% of the CNG segmentsprofitability and ~5.2% of the PNG segments profitability. But IGL spends ~15%-20% of its overall capex on the marketing business, incurs an operating expense of

~`0.50/scm for sale through its own CNG station or pays ~`0.90/scm to OMCsfor using their outlets. Hence the marketing margin doesnt seem to be on thehigher side. But even in the worst case if we assume that the marketing margin isreduced by 50%, then also the impact on the earnings would be less than 10% forIGL. Given that its stock price has corrected by 10% since the news of potentialregulation of marketing margin came in, we believe the market is factoring in the worst case and it provides a good opportunity to buy the stock. To provide acushion against the risk of marketing margin regulation, we have conservativelyassumed EBITDA margins to stabilise at ~`4.8/scm from ~`5.23/scm earnedduring FY12.

But for GGas, marketing margin constitutes ~25% of its profitability, given the lowcapex required for connecting the industrial segment. Hence GGas runs a higherrisk from the potential capping of marketing margin.


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Exhibit 51: IGL: Realisation breakdown ( /scm)

9.912.6

14.416.1

2.6

2.52.4

2.2

0

5

10

15

20

25

FY11 FY12e FY13e FY14e

PAT

Tax

Interest exp netof other income

Depreciation

Operating exp

Gas cost


Exhibit 52: GGas: Realisation breakdown ( /scm)

10.6

14.717.0 17.2

2.1

2.4

2.4 2.3

0

5

10

15

20

25

CY10 CY11e CY12e CY13e

PAT

Tax

Int exp net ofother income

Depreciation

Net operation

expense

Gas cost


Further, IGLs RoCE is expected to moderate going forward and stabilise at ~25%on account of significant capex being incurred by the company to ramp-up itsinfrastructure across the NCR region. As its returns are not significantly higher thanthe regulated return of 21% (pre-tax) allowed by PNGRB, we do not expect anysignificant scope for a cut in IGLs marketing margin.

But RoCE of GGas continues to be high at ~30% due to the low capex required toset up connectivity for Industrial consumers. As its return is significantly higherthan the regulated return of 21% (pre-tax), it runs the higher risk of a cut in itsmarketing margin.

Exhibit 53: IGL: Return ratios stabilizing at ~25%,implying lower risk from marketing margin

0%

5%

10%

15%

20%

25%

30%

35%

40%

FY11 FY12e FY13e FY14e FY15e FY16e

ROCE ROE


Exhibit 54: GGas: High return of ~30% posessignificant risk from marketing margin regulation

0%5%

10%

15%

20%

25%

30%

35%

40%

CY10 CY11e CY12e CY13e CY14e CY15e

ROCE ROE



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Oil & Gas February 23, 2012

Indraprastha GasBloomberg: IGL IN EQUITYReuters: IGAS.BO

Accounting: GREENPredictability: AMBEREarnings momentum: RED

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit

Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Please refer to the Disclaimers at the end of this Report.

BU

Exhibit 1: Key financials

Year to March FY10 FY11 FY12e FY13e FY14e

Sales volume (mmcmd) 2.14 2.73 3.34 3.87 4.51

Gross margin (`/scm) 7.45 7.62 8.02 7.79 7.50

EBITDA (`mn) 3,808 4,923 6,369 7,109 7,890

EBITDA (%) 35.3 28.2 25.4 22.7 20.3

EPS (`) 15.4 18.6 21.8 23.9 26.0

RoCE (%) 38.1 33.2 28.8 25.8 24.1

P/E (x) 22.6 18.7 15.9 14.5 13.3

Source: Company, Ambit Capital research

INITIATING COVERAGE

Dayanand MittalTel: +91 22 3043 [email protected]

Recommendation

CMP: `347


Upside (%) 17%

EPS (FY13): `23.9

Change from previous (%) NA


Stock Information

Mkt cap: `49bn/US$986mn

52-wk H/L: `454/285

3M ADV: `152mn/US$3.1mn

Beta: 0.6x

BSE Sensex: 18,145

Nifty: 5,505

Stock Performance (%)

1M 3M 12M YTD

Absolute 9.7 -10.3 13.9 -7.5

Rel. to Sensex 1.3 -23.3 14.7 -25.0

Performance (%)

10,000

15,000

20,000

25,000

Feb-11 Jun-11 Oct-11 Feb-12

100200300

400500

Sensex Indraprastha Gas

Cross cycle P/E band

9x12x

15x17x

7x

0100

200

300

400

500



A Capital play We prefer IGL due to its: (i) High allocation of domestic gas andefficient sourcing of LNG, (ii) Pricing power underpinned by itspresence in the cost competitive CNG segment and favourable taxtreatment of CGD in the NCR, and (iii) Strong volume growth potentialdue to its exclusive licence for setting up a CGD network in the hugeNCR market. Allocation of additional domestic gas, progress on dieselderegulation and capping of the LPG subsidy are potential positivetriggers. We Initiate with a BUY.

Competitive position: STRONG Changes to this position: STABLE

IGL has been allocated higher domestic gas as 91% of its sales are to theGovernment preferred CNG/PNG business. IGL is also likely preferred for anyincremental allocation of domestic gas. Furthermore, its strong parentage(GAIL owns 22.5%) gives it an edge in the efficient sourcing of LNG.

IGL has pricing power due to its significant presence in the cost competitiveCNG segment, low cost of gas due to the higher usage of domestic gas (1/3rdsthe cost of LNG) and favourable tax treatment for CGD in the NCR.

IGL has strong volume growth potential due to its exclusive licence forsetting up a CGD network in the extensive NCR market and its presence in theunder penetrated and Government-preferred CNG/PNG business. We expect16% volume CAGR over FY12E-FY16E. Allocation of low cost domestic gas andIGLs early mover advantage in Delhi should reduce the competitive threat

post end of the marketing exclusivity for Delhi. IGL has also bid for Ludhianaand Jalandhar CGD (in the state of Punjab) in the third round of auction heldby PNGRB in July 2010.

The stock has corrected by 10% over the last 40 days due to concerns thatIGLs marketing margin is likely to be regulated. This provides a good entrypoint as the market is factoring in a 50% reduction in its marketing margin, which looks unjustified given the capex, opex and risks involved in gasmarketing.

Valuation: Using a DCF-based model we value IGL at `406 (assuming cost ofequity of 14.0% and perpetuity growth of 4.5% from FY23) which implies anFY13 P/E of 17.0x, FY13 EV/EBITDA of 9.3x and P/B of 4.1x. This valuation

appears reasonable given the 16% volume CAGR expectation and 12%earnings CAGR over FY12-FY14. Although IGLs planned capex of`28bn overFY12E-FY16E would moderate its RoCE (FY11: 33%, FY16e:25%), RoCE is stillexpected to be strong at ~25%. Allocation of additional domestic gas, gradualderegulation of diesel, proposed capping of LPG subsidy and the continuedderegulation of petrol are the key positive catalysts for the stock.


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Indraprastha Gas


Company Financial Snapshot

Profit and Loss (` mn)FY11 FY12e FY13e

Net sales 17,441 25,087 31,363Op. expenses 12,518 18,717 24,254EBIDTA 4,923 6,369 7,109

Interest Expense 132 501 629Depreciation 1,029 1,428 1,528

PBT 3,857 4,476 5,001

Tax (1,259) (1,424) (1,650)

Adj. PAT 2,598 3,053 3,351Profit and Loss Ratios

EBIDTA Margin % 28.2 25.4 22.7

Adj PAT Margin % 14.9 12.2 10.7

P/E (X) 18.7 15.9 14.5

EV/EBIDTA (X) 10.8 8.8 8.1

Dividend Yield (%) 1.4 2.2 2.4

Company Background

Indraprastha Gas (IGL) was incorporated in December 1998,as a JV between GAIL, BPCL and the Government of Delhi

with an objective to supply CNG to the transport sector andPNG to the domestic and commercial sectors in the NCRregion.

IGL was incorporated post the Supreme Courts July 1998order seeking that all buses, three wheelers and taxis in Delhiadopt CNG as fuel. IGL has not only emerged as the solesupplier of CNG and PNG in the National Capital Territory(NCT) of Delhi but is also expanding its footprint in theNational Capital Region (NCR) cities of Noida, Greater Noida,Ghaziabad and Faridabad.

Balance Sheet (consolidated) (` mn)FY11 FY12e FY13e

Net Fixed Assets 11,594 17,566 22,038

Capital WIP 3,423 2,738 1,917

Investments 416 416 416Working Capital (528) (791) (886)Cash 173 81 529Total Assets 15,079 20,011 24,015Shareholders fund 10,039 11,887 13,915Debt 4,633 7,717 9,692

Total Liabilities 15,079 20,011 24,015

Balance Sheet Ratios

ROE % 28.4 27.8 26.0ROCE % 33.2 28.8 25.8

Net Debt/Equity (%) 44.4 64.2 65.8

Equity/Total Assets 0.8 0.6 0.6

P/BV (X) 4.8 4.1 3.5

Cash Flow (consolidated) (` mn)FY11 FY12e FY13e

Consolidated PAT 2,598 3,053 3,351

+ Depreciation 1,029 1,428 1,528

+ Deferred Tax Liability 170 - -

Cash profit 3,796 4,481 4,879- Increase in Current

Assets 700 843 + Increase in CurrentLiabilities 550 1,106 660

Operating cash flow 3,646 4,744 4,974

Gas Companies - Ambit - Feb 2011

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