IGL: What lies ahead?

The stock of Indraprastha Gas Ltd (IGL) has taken a beating of more than 30% in a single day on account of a directive issued by PNGRB (Petroleum and Natural Gas Regulatory Board) to the company to refund the excess network tariff and compression charges charged (referenced back to April 2008) by the company on gas sales. The regulator has cut down the Network & Compression Charges by around 63% and 59% respectively. We expect the company to challenge the decision in the Courts as it can have a significant impact on its earnings. A detailed notification is awaited from PNGRB regarding the refund for the past years.

The realization on gas sales comprises of gas costs, marketing margins and transportation tariffs of pipelines that a city gas distributor (CGD) charges. While gas costs is driven by demand supply dynamics, transportation tariff is set by regulator in a way that CGD earns a post tax return of 14% on the capital employed (RoCE). The marketing margin is decided by the CGD itself. However, recently there has been a buzz in the markets that the regulator is planning to regulate marketing margins as well.

Now, as per the regulatory Board, the company has been overcharging the customers as shown in the table.

	Charged by IGL	Approved by PNGRB	% change
Network tariff (Rs per mmbtu)	104.05	38.58	-63%
Compression charge (Rs per kg)	6.66	2.75	-59%

Source : PNGRB
The downward revision has been on account of difference in capex, volumes, maintenance and other expenditure and the time period that was submitted by IGL versus what has been considered by PNGRB.

Assuming a conservative case where the company has to follow the decision, we expect the following changes in our key estimates.

	Old estimates		New estimates
	2013E	2014E	2013E	2014E
Operating Profit Margins	23%	22%	18%	17%
Net Profit Margins	11%	11%	7%	7%
RoE	27%	26%	16%	16%
Diluted EPS (Rs per share)	25.9	30.3	14.6	16.7

Equitymaster estimates
As per the regulator, the closure to this issue could be affected only by June 2012 post some clarifications from IGL. We expect the company to approach the courts against the decision. Apart from that, there will be some upside to our revised estimates in case the regulatory Board decides to leave marketing margins untouched. In that case, the company will be able to improve realizations to some extent by compensating the loss on tariffs from the marketing margins.

Conclusion

While it is impossible to determine the exact impact of ongoing events on the estimates due to lack of clarity, one thing is very clear that the company will not be able to replicate the historical performance on the profitability front. We had come up with a 'Buy 'recommendation on the stock in April 2011 and our target price was met within a period of four months.

As per our revised estimates, we expect the Returns on Net Worth (RoNW) to come down to 16% by the end of FY14 (from 28% in FY11). Since the upsides to the stock price are very limited from the current levels, given the change in regulations, we would advise investors to Sell the stock, in case they did not do so when the target price was met.

Warm Regards
Team Equitymaster