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UBS Investment Research
Petronet LNG
Medium-term catalysts favourable
„ Play on supply-constrained Indian gas sector; rich parentage
We initiate coverage of Petronet LNG (PLNG), a regasifier of LNG, with a Buy
rating. We believe PLNG and GAIL (India) Limited (GAIL) are well positioned to
tap significant latent demand and medium-term supply constraints (KG-D6 block)
in India’s gas sector. PLNG’s promoters, including GAIL, are also its customers,
and we believe there is an incentive for GAIL to market LNG to drive throughput
of its new pipelines.
„ Limited risk; Kochi capacity and new Dahej jetty to increase capacity 75%
Due to mirror gas sales purchase agreements (GSPA), PLNG bears no risk on the
pricing, exchange rate, off-take, or marketing for the 7.5 mmtpa long-term volumes at
Dahej. The company’s Kochi terminal scale-up to 5 mmtpa by end-2012 and the opening of
the new Dahej LNG jetty in early FY14 will increase capacity 75% to 17.5 mmtpa.
„ Assume limited increase in regas margins; play on rising LNG volumes
We are cautious on the perpetual increase of Dahej regas margins as per the GSPA,
and assume flat margins beyond 2013. We forecast an FY10-13 EPS CAGR of
21.2% due to volume growth—51% of future capacity is tied in through long-term
contracts. We expect PLNG to scout for long-term contracts and continue to import
spot cargoes to boost operating leverage.
„ Valuation: growth supports valuation; Buy rating, price target of Rs150.00
PLNG’s valuations of 14.6x FY12E PE and 3.0x FY12E P/BV compare to the peer
medians of 15.8x and 2.4x. We expect medium-term catalysts and strong volume
growth to support the valuation premium over peers. We derive our price target
from a DCF-based methodology and explicitly forecast long-term valuation drivers
using UBS’s VCAM tool. We assume a WACC of 10.43%.
Investment Thesis
We initiate coverage of PLNG, a regasifier of LNG, with a Buy rating and
price target of Rs150.00. We consider it a play (along with GAIL) on the
significant latent demand and medium-term supply constraints in the Indian
gas sector. We believe medium-term catalysts favour PLNG, particularly gas
supply constraints at RIL’s KG-D6 block and GAIL’s pipeline capacity
expansion through 2012-13. We expect this to push more LNG. We expect the
valuation to remain at a premium due to new capacity and potentially higher
spot cargoes. We assume flat Dahej regas margins from 2013.
PLNG is backed by strong shareholders: the national utility companies Oil and
Natural Gas Corporation (ONGC), GAIL, Indian Oil Corporation (IOC) and
Bharat Petroleum Corporation (BPCL). Favourably, PLNG’s promoters are
also customers. Further, we think there is an incentive for GAIL to market
LNG to increase throughput of its new pipelines.
PLNG is solely a regasifier and due to mirror GSPA, bears no risk on the
pricing, exchange rate, off-take, or marketing for the 7.5 mmtpa term volumes
at Dahej, due to mirror gas sales purchase agreements (GSPA) with marketers.
We think gradual linkage to Japanese crude cocktail (JCC) prices from 2009 to
2013 for Dahej long-term contracts with a cap and floor, and lower spot prices
will enable PLNG to push more LNG volumes to price-sensitive Indian
consumers. In India, LNG supplements gas from cheaper sources.
PLNG plans to expand capacity 75% to 17.5 mmtpa by early FY14. The Kochi
terminal will scale-up to 5 mmtpa by end-2012 and the new Dahej LNG jetty
is to open by early FY14. About 51% of future capacity is tied in through
long-term supply from Qatar and Australia, supported largely by back-to-back
mirror GSPAs. We think residual volumes are likely to be through spot or
short-term contracts until PLNG secures more long-term volumes.
We forecast favourable volume growth (FY10-13 volume CAGR of 14.9%).
We assume flat regas margins of Rs31.7/mmbtu for Dahej from 2013, as we
think a perpetual increase (as per the GSPA) looks difficult since we think
PLNG has good IRRs. The start-up of Kochi will also facilitate volume
growth. Management has not guided for specifics on Kochi regas margin.
However, we believe it is likely on a 16% IRR on long-term volumes. We
estimate regas margin at Rs50/mmbtu. PLNG makes marketing margin only
on spot cargoes, which vary with the industry environment. We forecast an
above-peer FY10-13 EPS CAGR of 21.2%. LNG is a high fixed-cost business,
and incremental operating leverage would be positive for earnings growth.
As a pure tolling company PLNG has no direct comparables. However, given
the nature of its business, regas margins are largely determined on IRRs, we
compare it with global utility companies. PLNG’s comparative valuations are
above its global peers. The stock is trading at 3.0x FY12E P/BV at an ROE of
22.4%. In our view, the stock could look fairly priced at a moderate growth rate.
However, our DCF valuation indicates a much higher valuation based on our
forecast above-peer FY10-13 EPS CAGR. We believe EPS growth and several
positive catalysts will continue to support a premium valuation for the stock.
We believe the key risks to our estimates are faster-than-expected scale-up of
KG-D6 gas production and development of other gas discoveries, volatile
crude prices, difficulty in sourcing term/spot LNG and higher competition, as
LNG in India is under open general license and has low entry barriers.
Key catalysts
Q We believe domestic gas supply constraints over the medium term are the
key catalyst for the stock, as they give PLNG an opportunity to sell higher
spot cargoes beyond its term sales. Gas supply in India seems constrained at
160-163 mmscmd, as Reliance Industries Limited (RIL) indicates reservoir
issues with the KG-D6 block. As per media reports, the Directorate General
of Hydrocarbons (DGH) indicates scale up of the D-1, D-3 and MA fields
(associated gas) only in 2012-13. Possible surprises on spot cargoes also
expand the potential for good quarterly results. New GAIL pipelines
facilitating higher connectivity increase the potential for higher LNG sales.
Q Significantly, the commissioning of GAIL’s new pipeline capacity in
2012/13 will facilitate PLNG pushing higher volumes to latent demand
centres; this will expand operating leverage and provide opportunities to sign
more long-term GSPAs with customers. Also note that PLNG’s promoters
are the company’s customers, and we think there could be a higher
incentivee for GAIL to market LNG to increase throughput of its new
pipelines.
Q PLNG has secured 51% of its future capacity through long-term contracts.
We think global LNG oversupply until 2013 will enable PLNG to sign new
LNG sourcing agreements at reasonable prices. This could add further
certainty and address the long-term viability of the business model. Weak
gas spot prices would also enable PLNG to import and sell more spot cargoes
for the price-sensitive Indian consumer.
Q We expect the Kochi capacity commissioning and new Dahej LNG jetty to
expand the company’s capacity 75% to 17.5 mmtpa by FY14, and think this
will expand LNG sales and also tie in new demand areas in southern India.
Risks
Earlier-than-expected scale up of KG-D6 volumes and other blocks (like those
of GSPC, ONGC, etc) would negatively impact investor sentiment and
potentially slow capacity utilisation increase at PLNG’s new terminals. We
think this could lead valuations to correct from premium to in-line with peers.
Higher crude prices could make LNG more expensive for the price-sensitive
Indian market, as PLNG’s Dahej term links to crude from January 2014. Though
this would not impact PLNG’s financials, at least over long-term volumes,
higher spot cargoes might be a challenge: about 51% of PLNG’s capacity is
booked through long-term contracts. We expect the remainder to be spot
contracts until the company ties in more supply and signs GSPAs.
Higher competition from other LNG terminals like the recently revived Ennore,
Dabhol and Mundra terminals, etc, could impact PLNG’s potential future market
and lower spot cargoes. Some of these terminals have been revived by PLNG’s
promoters.
We are cautious on the perpetual increase in regas margins at the Dahej terminal,
as PLNG’s IRRs are favourable, and its margins are already within international
regas margins range, we therefore assume a flat Dahej regas margin from 2013.
Difficulty in sourcing LNG for spot and long-term contracts could also be a risk.
PLNG has historically sourced long-term LNG quite gradually, and any
difficulty in signing more long-term contracts at attractive pricing, or a lack of
spot cargoes, could hinder the scale-up of its Dahej and Kochi terminals. PLNG
has secured about 51% of its future capacity through long-term supply
arrangements.
Valuation and basis for our price target
We derive our price target of Rs150.00 from a DCF-based methodology and
explicitly forecast long-term valuation drivers using UBS’s VCAM tool. In our
view, DCF captures the financial impact of the planned capacity expansions and
the potential opportunity to import spot cargoes—as well as RIL KG scale-up
constraints and new GAIL capacity. We assume a WACC of 10.43%, taking
into account the government company promoters (better corporate governance,
limited marketing risk, mirror GSPAs for term contracts) and lower stock beta.
We forecast limited FCF growth beyond 2020.
VCAM is a DCF and economic profit model
VCAM is based on the established principles of discounted cash flow (DCF) and
economic profit analysis (EPA) This framework reconciles DCF and EPA
valuation methodologies by calculating economic profit along with free-cash
flow for each year. The accompanying economic profit forecasts reveal whether
or not free-cash flow is value-added. It is economic profit growth that justifies
an intrinsic value greater than the worth of a company's current earnings valued
in perpetuity.
VCAM assumes: Company DCF Value = Current earnings [NOPAT] valued in
perpetuity +present value of all future incremental economic profit. One of the
key assumptions in the VCAM model is the value creation horizon (VCH),
which refers to the number of future years a company is expected to generate
incremental economic profits. At the end of the VCH, we value the NOPAT into
perpetuity to calculate terminal value. The major subjective drivers of our
VCAM price targets are long-term margin assumptions and the weighted
average cost of capital (WACC). The summary tables come from VCAM and
clients are free to modify the data and/or use their own assumptions on our
website (www.ubs.com/investment research). The site also has a number of
tools including sensitivity analysis, long-term trends, and a goal seeker.
Growth supports valuation: medium-term catalysts
Our implied valuations on PLNG are slightly higher than the peer group on most
estimates. This is because our DCF indicates a much higher valuation based on
higher forecast earnings growth. The stock seems fairly priced compared to
global peers at 3.0x FY12E P/BV at an ROE of 22.4%. We expect higher
earnings growth and medium-term catalysts to support the valuation premium
over peers.
UBS versus consensus
Our EPS estimates are broadly in line with consensus estimates. We think the
difference in revenue estimates is likely due to differing crude and hence LNG
FOB price assumptions (linked to crude forecasts). EBITDA differences could
be due to differing regas margin or possibly volume assumptions.
Sensitivity analysis
Our FY12 and FY13 earnings estimates are significantly sensitive to both
volumes and regas charges. We have assumed a decline in regas margin in 2012,
and thereafter assume it will be constant at Rs31.7/mmbtu (US$0.72/mmbtu).
For volumes, we assume increasing operating leverage at the Dahej terminal, on
gas supply constraints and new pipeline connectivity
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