Case 048Stock pitchCore

Energy stock pitch: Ujjanta Gas Distribution, a city gas distributor with volumes growing 9%, a margin of Rs 7 per standard cubic metre and 30% of its gas bought at spot prices. Pitch it and handle the gas cost pass-through question.

Franklin TempletonSan Mateo · 2024

The situation

Ujjanta Gas Distribution supplies piped gas and CNG in four cities. It sells 8 million standard cubic metres (scm) a day, and volumes are growing 9% a year as it adds CNG stations and industrial connections. Its average selling price is Rs 45 per scm after taxes. It buys 70% of its gas under long-term contracts at Rs 30 per scm and 30% as spot LNG, now Rs 40, so gas costs Rs 33 per scm; operating costs are Rs 5. That leaves an EBITDA margin of Rs 7 per scm, Rs 2,044 crore a year.

About 55% of volume is CNG for vehicles, where the alternative is petrol or diesel. The other 45% is industrial, where customers can switch to other fuels if gas becomes too expensive. You are pitching the stock to an associate who covers energy.

Your task

Give the pitch, then answer the question you will certainly get: what happens if spot gas jumps to Rs 60?

Quick check

Spot gas rises from Rs 40 to Rs 60 and Ujjanta passes on nothing. What happens to the margin per scm?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

The pitch: 9% volume growth at a steady Rs 7 margin compounds EBITDA from Rs 2,044 crore to about Rs 2,647 crore in three years; the thesis rests on passing gas costs to customers. Each Rs 1 per scm of margin is worth Rs 292 crore, 14% of EBITDA. If spot rises to Rs 60, cost rises Rs 6 per scm; CNG can pass it on, industry only about half, so the margin settles near Rs 5.65, after a quarter or two at lower levels.

Step 1What is the pitch in three sentences?

A milk cooperative that buys most of its milk on fixed contracts and sells to households who have no easy substitute has a steady business; the risk is the share it buys on the open market. Ujjanta grows volume 9% a year from new CNG stations and industrial connections, earns a stable Rs 7 per scm because 70% of its gas is contracted, and so compounds EBITDA at close to 9% with little new capital per unit. That is the long case. It holds only if the 30% of gas bought at spot does not squeeze the margin, which is where every energy interviewer will go next.

Step 2What happens to the margin if spot gas jumps?

Work it per scm. Spot rising Rs 20 on 30% of the gas adds Rs 6 to the cost of every scm sold; with no pass-through the Rs 7 margin becomes Rs 1. But pass-through differs by customer. CNG drivers compare with petrol and diesel, which cost far more per kilometre, so Ujjanta can raise CNG prices by the full amount. Industrial users can switch fuels, so assume only half passes there. Weighted, 55% of volume at full pass-through and 45% at half gives 77.5%, and the margin settles near Rs 5.65.

The thesis rests on pass-through: margin per scm against spot gas, Rs-40471013spot today Rs 40Full pass-through: Rs 7 holdsLikely: 77.5% passed onRed line: no pass-throughRs 1.0 at spot 60Rs 5.65Rs 20Rs 40Rs 60Rs 80Spot LNG price, Rs per scm
With 30% of gas bought at spot, Ujjanta's Rs 7 margin per scm holds with full pass-through, falls to Rs 1 at a Rs 60 spot price with none, and settles near Rs 5.65 if CNG passes on fully and industry half.
The relationship
m=7−0.30×(S−40)×(1−p)mS=60=7−6×(1−0.775)≈5.65m = 7 - 0.30 \times (S - 40) \times (1 - p) \qquad m_{S=60} = 7 - 6 \times (1 - 0.775) \approx 5.65
mEBITDA margin, Rs per scm
Sspot LNG price, Rs per scm
0.30share of gas bought at spot
pshare of the cost rise passed to customers
What it says in wordsThe margin falls by the spot share times the price rise times whatever part is not passed on.
Step 3How big is the margin risk against the growth?

Put both in rupees. Each Rs 1 per scm of margin is Rs 292 crore of EBITDA, 14% of today's figure, so a Rs 1.35 margin hit costs more than three years of 9% volume growth adds. If spot stays at Rs 60, year 3 EBITDA is about Rs 2,137 crore instead of Rs 2,647 crore. Even full pass-through is not instant: CNG prices are usually revised with a lag, so expect one or two weak quarters in any spike.

Three years of volume growth against one margin shock, Rs crore2,044Today2,2281,798Year 12,4281,960Year 22,6472,137Year 3Margin holds at Rs 7Spot at Rs 60, margin Rs 5.65
At a steady Rs 7 margin Ujjanta's EBITDA grows from Rs 2,044 crore to Rs 2,647 crore in three years; if spot gas stays at Rs 60 and the margin settles at Rs 5.65, year 3 EBITDA is only Rs 2,137 crore.

Close the pitch with the monitorable. The share of gas bought at spot, and the gap between CNG and petrol prices per kilometre, are the two numbers that tell you each quarter whether the thesis is intact. If contracted supply shrinks and the spot share rises towards half, the business becomes a spread trade on LNG and deserves a lower multiple.

Where candidates lose it

The common loss is answering the spike question with the whole Rs 20 per scm, as if all gas were bought at spot. Only 30% reprices; saying Rs 6 shows the interviewer you read the cost structure.

The second is claiming full pass-through for everyone. Industrial customers have alternatives and will switch, so a pitch that assumes they pay any price has not thought about who the customer is.

What the interviewer asks next

  • What CNG price rise would be needed to pass on the full Rs 6, and could vehicles switch back to petrol?
  • How would you value Ujjanta's exclusivity in its cities as it approaches expiry?
  • Electric vehicles take 20% of new car sales in its cities. What happens to the CNG volume forecast?

Asked at Franklin Templeton, Oil & Gas, San Mateo, 2024 (Wall Street Oasis): a stock pitch I had prepared for the interview

Company names and figures are illustrative.