Gujarat Gas Company Ltd. (GUJARATGAS) is India’s largest private sector company in natural gas transmission and distribution. As the name suggests operations are in state of Gujarat. It distributes natural gas to industrial, commercial, and domestic customers. British Gas Group has a majority of the stake of close to 65% stake in the company. Few key aspects that I like about Gujarat Gas are its business model of gas distribution and practically debt free balance sheet.

Trend Analysis

The whole reason for any business to exist is to generate sales revenue and make more profits. At a minimum, the parameters listed below should have continuously increasing trends. All the data below is based on last 8 years i.e. from 2000 to 2008.

• Revenue: Increasing trend with average growth of 21% (SDev. 15%). Good observation.
• Earnings per share: Increasing trend with average growth of 18% (SDev. 30%). This shows it possibility of negative growth. Neutral observation.
• Net cash flow from operations: Overall, an increasing trend. The net cash flow is always greater than reported net profit. Very good observation.
• Profit/Loss from operations: Consistently increasing trends in profits from its operations. Good observation.
• Reported net profit: Overall an increasing trend. Good observation.
• Gross margins: Current GM of 16.05% is less than historical average of 20%+ (stdev. 9.21%). Need to keep an eye on.
• Operating margins: Current OM of 19.17% is less than historical average of 21%+ (stdev. 8.66%). Need to keep an eye on.

Quality of Dividends

In this part of my analysis, I am trying to understand dividend growth rate, consistency, and ability of the corporation to demonstrate sustainability. In is also an indirect way to gauging management’s policy vis-à-vis sharing of profits with common shareholders.

• Dividend per share: Chart 3 shows that stable dividend payments. However, it lacks sustained growth. However, if we take two special dividends into consideration, it covers for the lack of slow growth. Neutral observation.
• Payout factor: This is ratio of dividends per share divided by EPS. Excluding two special dividends, the payout factors has been more or less 20% or below. Very good observation.
• Dividend growth rate: The dividends have not grown at sustained year-on-year basis. However, if we include two special dividends, then average growth rate is 67%. This is more than EPS growth rate of 18%. Excluding the special dividends, the growth rate is in line with EPS growth rates. Neutral observation.
• Ratio of cash from operations to reported net profit: This ratio is consistently more than 1.0. Very good observation.
• Ratio of profits from operations to reported net profit: This ratio is consistently more than one. Very good observation.
• Ratio of Cash from operations to total debt: This ratio is consistently more than one. Not shown in the plot because it exceeds the scale. In fact, the corporation can be considered practically debt free based on its operational cash flow. Very good observation.

Dividend Cash Flow vs. Risk Free Savings Cash Flow

Why should I take risk if I can get a same or more cash flow by putting my capital into any risk free savings, fixed deposits, or any such risk free accounts? Therefore, I try to understand how dividends will affect my cash flow in 10 years of time period. The baseline assumptions are (1) the stock’s dividend yield is 0.8% at current price of Rs. 363; and (2) savings interest rate is 7%.

• Best case scenario: considering average dividend growth rate of 67% for last nine years, the dividend cash flow will be 6.56 times the cash flow from savings interest at the end of 10 years.
• Worst case scenario: considering low end of the expected dividend growth of 15%, the dividend cash follow will be only 0.23 times the cash flow from savings interest at the end of 10 years.
• In order to have equal cash flow (i.e. dividends = savings interest) in 10 years time period, the current yield should be 3.7% with average dividend growth of at least 15%. At this yield the buy price is Rs. 82.

Projected Beta-based Expected Return

I measured Beta for this stock’s risk (or price movement) relative to the S&P CNX NIFTY (or index movement). Here, I am trying to understand how a stock price behaves relative to the market and how to factor in the capital appreciation into my expected beta returns.

• The stocks three year Beta value is 0.36. This means this stock is relatively less volatile w.r.t. S&P CNX NIFTY index.
• The expected return is 10.1% relative to market index.
• Now factoring in 10.1% of expected return into the worst case dividend growth of 15% and current yield of 0.8%, the total cash flow is 2.1 times the savings interest rate.

Fair Value Calculation

The next step is to estimate the fair value so that we can understand return characteristics for this investment.

• NPV price based on 15 year DCF: Rs. 252.5
• Average high yield price calculated based on past 9 years: Rs. 211.8
• Pricing relative to 9 year average PE ratio: Rs. 341.6
• Pricing based on PE ratio of 12: Rs. 295.5
• Graham number: Rs. 243.1

The range of fair value is calculated as Rs. 243.6 to Rs. 268.9

Adding NOTE on December 30, 2009: In mid September 2009, Gujarat Gas issued 1:1 bonus shares which were paid by the reserves. Therefore, the total equity got diluted to 2x. With this dilution, the range of fair value for me to buy Gujarat Gas will be Rs 137 to Rs 156.

Qualitative Analysis

• I like stable and sustainable business model of Gujarat Gas. While its market positioning is not unique, competitors will require large capital and time period to pose any significant challenge in short to intermediate term.
• Practically, it has a zero debt levels. It is funding its growth from its own internal resources by utilizing higher earnings and higher cash flow from its business.
• Excluding the special dividends it does not seem to have a very favorable dividend strategy. Who knows if there will be any similar special dividends in future.
• Considering the long term growth prospect of Indian economy and continued focus to use up natural gas (instead of burning it), I believe Gujarat Gas is very well position for continued future growth.
• The company is exposed to gas supply from its sources e.g. Supply disruptions from GAIL caused a reduced earnings in 2008. It needs to diversify its supply sources.

Summary…

I would like to buy shares of Gujarat Gas for long term capital appreciation and dividends. It seems to be a well managed company with rational and prudent financial management. Based on what I could read, I like the approach of funding growth without taking leveraged risk or messing with balance sheet. The table below shows the return characteristics of the investment scenario for next 10 years (Note: this return characteristic is relative to savings cash flow and relative to index performance).

I will wait for the stock to come near from buy range. It is not priced right for me to buy. Like me, there are many who think it is a good stock and hence it is already priced in.

Full disclosure: No position at the time of this writing.

Disclaimer: This analysis is in the context of my long term investment philosophy. It is in line with my investment objectives and my personal risk profile. Please do your own research before making an investment decisions for Gujarat Gas.

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