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Gujarat State Petronet (GSPT.BO)
Short-term Pain, Long-term Gain
Buy for long-term gain — Near-term concerns on vol growth have continued to
impact sentiment on GSPL. We, however, would advise investors willing to take a
longer term view to buy the stock, which trades at 1-yr fwd P/E and P/CEPS of 9.7x
7.5x standalone (8.8x and 6.9x if associate income incl.), compared with peer multiples
of 14-16x and 10-12x. The stock, in our view, is pricing in either one of two bear-case
scenarios: (i) flat vols till perpetuity, flat tariffs, and nil value for new pipelines; or (ii)
10% cut in tariffs, modest vol growth, and -ve value for new pipelines – take your pick!
Bear scenario #1: Flat tariffs, no vol growth, nil value for new pipelines = Rs90/sh
— We look at various scenarios and our discretion to judge what the stock is pricing in.
Were we to assume — (i) no vol growth till perpetuity (i.e., vols stay at current levels of
~36-37 mmscmd), (ii) tariffs remain at ~Rs800/tcm (FY10 avg was Rs850, FY11 avg
was Rs794, though the latter would be Rs810 ex. one-offs), and (iii) the three new
pipelines are accorded nil value — we arrive at a Rs90/sh value for the stock. For
investors +ve on the longer term gas outlook in India who believe vols will eventually
rise (in line with our belief outlined in our report titled, 'Where Is The Gas? Providing
Some Answers' dated 23 June), now would be an opportune time to buy, in our view.
Bear scenario #2: 10% tariff cut, modest vol growth, -ve value for new pipelines =
Rs93/sh — Key assumptions: (i) tariffs are cut to ~Rs720/tcm (~10%); (ii) vols peak at
45 mmscmd in FY14 (as the Dahej, Hazira, and Dabhol LNG terminals ramp up); and
(iii) the three new pipelines are value destructive (-Rs5/sh) for GSPL. Once again, we
would encourage investors to use the current stock price as a buying opportunity, esp.
for those who believe there is limited downside to GSPL’s tariffs (based on GAIL’s tariff
reset last yr) and that demand-supply forces in India will ensure pipeline infra is a
sound investment (GSPC itself will significantly contribute to vols through start up of its
KG gas vols in CY13 and from new LNG terminals at Mundra and potentially Pipavav).
12-mth TP of Rs142 — This includes core network value of Rs118 (DCF) and value
accretion from new pipelines o f Rs24 (30% discount to DCF for uncertainties/delays).
Gujarat State Petronet
Company description
GSPL is a gas transmission company with a network of pipelines in the western
Indian state of Gujarat. It has a gas transmission network of over 1,600km of
pipeline connecting Hazira, Vadodara, Ahmedabad, Kalol, Himmatnagar, Mehsana,
Rajkot, and Vapi. GSPL's network connects all major supply sources in Gujarat to
important consumption centres in the state and transports c38 mmscmd of gas.
Investment strategy
We rate GSPL shares Buy/Medium Risk (1M). GSPL has set up an "open access"
pipeline network in India's most vibrant gas market, Gujarat. Gujarat is the landfall
of gas from India's western offshore fields (India's largest source of gas) with two
LNG receiving terminals. The state is also among the most industrialized regions in
India with a large presence in energy-intensive industries and traditional gas-using
industries. GSPL's parent, Gujarat State Petroleum Corporation, continues to play
an important role as an aggregator of gas demand and supplies. GSPL is highly
levered to increasing supplies of gas in India. Despite the lack of clarity in ramp-up
of gas from KG-D6, steadily increasing LNG volumes (through announced and
prospective expansions) should boost its transmission volumes - a key positive.
Concerns on its existing tariffs are overdone, in our view, and clarity, which is
expected in the next few months, could remove a key stock overhang. GSPL has
recently won bids for three new pipelines Mallavaram-Bhilwara, Mehsana-Bhatinda,
and Bhatinda-J&K, which we believe are value accretive wins and an added
material positive.
Valuation
Our Rs142 target price is based on: (i) our Sep-11E DCF fair value of Rs118 for the
existing business, (ii) Rs14/sh value accretion from the Mehsana-Bhatinda pipeline,
and (iii) Rs10/sh value accretion from the Mallavaram-Bhilwara pipeline. Our DCF
assumptions for the existing business are based on incremental gas volumes of 9-
10 mmscmd to be consumed in Gujarat, and announced capex plans. We use DCF
given the utility nature of the business, with steady cash flows, and to capture the
value of the business over the longer term. Our DCF valuation is based on explicit
forecasts until FY14E, an 8% CAGR of volumes over FY11-14E, FY14E transported
volumes of 44 mmscmd, and a terminal growth of 3.0%. We use a WACC of 10.5%
(risk-free 8.0%, risk premium 6.0%, beta of 0.9, cost of equity 13.3%, cost of debt
10.0%, target D/E of 0.75x). For the new pipelines, we value Mehsana-Bhatinda at
Rs21/sh and Mallavaram-Bhatinda at Rs14/sh based on our DCF analysis (yielding
16% and 13% IRRs respectively). We, however, take a 30% discount to the DCF
values for these pipelines in our target price to factor in risk of delays in execution,
regulatory approvals, etc. On an adjusted P/B basis, GSPL would trade at 2.3x
FY13E on our core DCF-value of Rs118, which we believe is reasonable given
adjusted ROEs of ~20% over the next few years.
Risks
We assign a Medium Risk rating to GSPL, even though our quantitative risk rating
system suggests a Low Risk, given concerns on near-term volume growth and
regulatory uncertainty on tariffs. Key downside risks that could prevent the shares
from reaching our target price include: 1) Adverse impact, if any, of regulation of gas
pipeline tariffs by the Petroleum and Natural Gas Regulatory Board; 2) Delay in
ramp up of new gas supplies; 3) Project risk - GSPL is implementing expansion of
its pipeline network that is subject to time and cost over-runs that could impact
earnings; 4) Worsening of economics of LNG, which could impact volumes; 5)
Significant delay in authorizations of its new pipelines, and 6) Political risk - we
currently assume no contribution towards socio-economic projects; however, since
the social tax has not been officially revoked by the gov't, this poses a risk.
GAIL
(GAIL.BO; Rs468.25; 1L)
Valuation
We adopt DCF as on Sep-11E as our primary valuation methodology, which yields a
target price of Rs502 (including Rs90 value of investments). We employ a two-stage
DCF process. We use a WACC of 10%, target D/V of 50%, a risk-free rate of 8%,
risk premium of 6%, beta of 0.8, and terminal growth rate of 4%. We cross-check
our DCF valuation with our EV/EBITDA methodology, which returns a value of
Rs506. This alternative valuation methodology imputes an EV/EBITDA of 7x for the
cyclical (LPG/petchem) businesses, and 10x for the gas business. Adding the value
of investments (Rs90) yields a value per share of Rs506, which ties in with our DCF
valuation.
Risks
We rate GAIL shares Low Risk as transmission volumes have ramped up with the
commencement of KG gas, clarity on new tariffs has alleviated concerns, while
simultaneously, cyclical businesses have become less critical for the company's
growth. The main risks that could impede the stock from reaching our target price
are: 1) GAIL's petrochemical business is cyclical; 2) changes in government policy
relating to oil sector subsidies will likely remain a risk to earnings and stock
sentiment; and 3) execution risks, given the large investments that GAIL is
undertaking in expanding its pipeline network, could lead to time and cost over-runs.
Indraprastha Gas
(IGAS.BO; Rs388.40; 1L)
Valuation
Our target price of Rs425 for IGL is based on DCF. We prefer to use DCF, as it
captures the value of the projects over their lifetime. IGL's near-term cash flow is
affected by its aggressive expansion. In our DCF analysis, we have used explicit
forecasts till FY14E, an intermediate growth rate of 10% till FY17E, and a terminal
growth rate of 4%. We use a WACC of 10.8% (stock beta of 0.7, risk free rate of
8%, market risk premium of 6.0%, target D/V of 25%). Our target price imputes a
P/CEPS of 11x FY12E. We prefer to use P/CEPS as a comparison due to the utility
nature of IGL's business and the high depreciation rates on its assets.
Risks
We rate IGL shares Low Risk in line with our quantitative risk-rating system.
Downside risks that could prevent the stock from reaching our target price include:
(1) IGL’s inability to increase CNG/PNG prices despite rising gas costs; (2)
Regulatory scrutiny of margins, and (3) Lower-than-expected conversion of vehicles
to CNG and/or penetration of PNG resulting in lower-than-expected volume growth.
Petronet LNG
(PLNG.BO; Rs141.50; 1L)
Valuation
Our target price of Rs155 is based on our DCF-based fair value estimate for Mar-
12E. We use a DCF-based valuation, as we think it captures the value of the
projects over their lifetime, especially given that PLNG's near-term cash flow is
affected by its aggressive expansion. In our DCF analysis, we use explicit forecasts
for seven years, long-term volumes of 16.5 MMTPA, a terminal growth rate of 3%,
and a WACC of 10.8% (based on risk-free rate of 8.0%, cost of debt of 9.5%, target
D/E of 1:1, beta of 1.2x, market risk premium of 6.0%).
Risks
We rate PLNG shares Low Risk as opposed to Medium Risk as suggested by our
quantitative risk-rating system, which tracks 260-day historical share price volatility.
We believe that with visibility on near-term volumes increasing and capex plans on
schedule, risks for the stock stand mitigated. Key downside risks which could prevent
the shares from reaching our target price include: 1) continued high prices of LNG
making it difficult for PLNG to sign a long-term contract, 2) quicker-than-anticipated
ramp-up of production of cheaper-priced gas from domestic fields, 3) delay in
expansion of pipeline infrastructure which could negatively impact PLNG's volumes,
and 4) any delays in the completion and commissioning of the Kochi terminal.
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