MANI
Shares of Indraprastha Gas Limited (IGL) witnessed a sharp decline yesterday. The price dropped nearly 20% in a single trading session. This sudden fall raised concerns among investors. Long term investors, those holding IGL for long-term wealth creation, are more worried about future outlook of the stock. In this post, we’ll analyze the reasons behind this steep decline and explore what lies ahead for IGL from a long-term investor’s perspective.
Topics
1. Reasons for the IGL Share Price Fall
1. 1. Reduction in APM Gas Allocation
The primary reason for IGL’s share price plunge is the government’s decision to reduce gas allocations under the Administered Price Mechanism (APM). APM gas is provided at a lower, controlled price, which helps city gas distributors (CGDs) like IGL maintain profitability.
- Recent Cuts: Over the past month, the allocation of APM gas to gas distributors (CGDs) has been reduced twice, cumulatively by about 35–40%.
- Impact on Costs: With less access to cheaper APM gas, IGL will now rely more on costlier alternatives. Spot LNG and New Well Gas are the next alternative which can significantly raise the gas distributor’s (CGDs) input raw material costs.
Why Indian government is reducing the gas allocation? The main reason is the decline in output from legacy gas fields. This reduction in domestic gas production has led to a shortfall in supply, prompting the government to prioritize allocation to other sectors or to encourage city gas distributors to source gas from more expensive alternatives like high-pressure high-temperature fields or imported LNG, which impacts profitability and forces price adjustments.
A Few examples of Legacy Gas Fields that cater to the demand of Natural Gas in India:
- Bombay High (ONGC): Over time, as with many mature oil and gas fields, the natural decline in reservoir pressure has led to reduced output. Enhanced recovery techniques are used to extend the life of the Bombay High Field. But overall, the production has decreased from its peak.
- Bassein Field (ONGC): Similarly, as a mature field, Bassein’s production has seen a decline. The field’s output has been supplemented by secondary recovery methods. But like Bombay High, the Bassein Filed struggles with natural depletion.
- Cambay Basin (ONGC): This Cambay basin has multiple fields, some of which are ageing. While there are efforts to enhance production through new technologies or drilling techniques, many of the older fields within this basin are experiencing reduced output.
- Krishna Godavari Basin: While newer discoveries in this basin (by Reliance Ind KGD-6) have provided a boost, the legacy fields within this region are also facing production declines. The newer fields might offset this in total basin output. But individually, many of these older fields are producing less.
This decline in production from legacy fields is a common phenomenon in the oil and gas industry where fields deplete over time unless significant new investments are made in enhanced recovery or new wells are drilled.
1. 2. Profit Margin Compression
Reduced access to low-cost gas squeezes profit margins for IGL. The core segments, like compressed natural gas (CNG) and piped natural gas (PNG), are mainly effected by the increase input gas prices.
- Price Hike Constraints: While IGL may need to raise prices to offset higher costs, passing on the entire increase to customers could affect demand.
- Elections and Policy Challenges: Regulatory and political challenges, such as upcoming elections in Maharashtra, further complicate the timing and extent of price hikes.
1. 3. Analyst Downgrades
Several brokerages have downgraded IGL’s stock in response to the policy changes.
- Lower Earnings Expectations: Analysts predict a significant decline in IGL’s EBITDA margins, with some estimating a hit of 40–60% if price hikes are not implemented.
- Target Price Cuts: Brokerage firms like Jefferies, Citi, and Nuvama have reduced their target prices for IGL, reflecting lowered growth expectations.
1.4. Policy Uncertainty
The market views the rapid and unanticipated cuts in APM gas allocation as a negative signal for the CGD sector.
This has created uncertainty around future policy directions, deterring both retail and institutional investors from holding CGD stocks like IGL.
2. Future Outlook for IGL’s Shares
For long-term investors, the immediate turbulence in IGL’s stock price might feel unsettling.
However, let’s consider the broader picture to evaluate the potential for recovery and growth over the next 5–7 years.
2.1 Core Business Resilience
Despite short-term headwinds, IGL operates in a sector with robust demand fundamentals. The push towards cleaner energy sources and urban expansion will continue to drive demand for CNG and PNG in the long run.
- Government Focus on Green Energy: Policies promoting a shift to natural gas over conventional fuels like petrol and diesel provide long-term growth opportunities.
- Market Position: IGL remains a leader in the CGD space. They have a strong foothold in Delhi NCR and neighboring regions.
2.2 Need for Pricing Adjustments
The company’s ability to navigate the current crisis will depend on how effectively it manages price increases.
- Gradual Hikes Possible: While large-scale hikes may impact demand, a phased approach could allow IGL to recover lost margins without severely affecting volumes.
- Role of Elections: Post-election, IGL may find more room to raise prices and stabilize earnings.
2.3 Potential Policy Stabilization
The government’s sudden reduction in APM gas allocations has underscored the urgency for a more stable and transparent policy framework in India’s natural gas sector.
Investors and companies within the City Gas Distribution (CGD) sector have been caught off-guard by these changes.
A more predictable policy environment would not only stabilize expectations but also allow for better long-term planning by these companies.
This could involve clearer timelines on allocation reductions, criteria for alternative sourcing. It will allow the companies adequate time to adjust their business models.
2.4 Long-Term Growth Catalysts
- Urban Expansion: As urbanization accelerates, the demand for PNG and CNG will continue to grow.
- Technological Advancements: Innovations in energy distribution and efficiency could enhance IGL’s operational capabilities.
- Diversification Opportunities: IGL may explore diversifying its gas sourcing to reduce dependency on APM gas, mitigating risks in the future.
Conclusion
The recent fall in IGL’s share price reflects immediate challenges stemming from reduced APM gas allocations and policy uncertainty.
However, for long-term investors, the company’s strong fundamentals, leadership in the CGD space, and demand growth drivers offer reasons for cautious optimism.
While the road to recovery may take time, for myself, with a 5–7 year horizon, I personally view the current price correction as an opportunity to accumulate IGL shares at attractive valuations.
However, it’s crucial to remain mindful of the risks and monitor developments in government policy and pricing adjustments.
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Have a happy investing.