Petronet LNG: BUY

In a year when stocks across the spectrum came crumbling down, liquefied natural gas (LNG) importer and regasifier, Petronet LNG, has held up on the bourses. Compared with the 25 per cent fall in the Sensex since the beginning of calendar 2011, the Petronet stock has gained around 28 per cent. This is primarily due to the company's solid showing on both the operational and financial fronts, thanks to favourable industry dynamics for LNG. Petronet is India's dominant LNG player, accounting for more than three-fourth of the installed LNG capacity in the country.

The stock, however, has been an underperformer over the past four months (down 12 per cent). Concerns that the spurt in the price of spot LNG may dent demand have contributed to the weakness. Also, with the company already operating above its existing 10 mtpa capacity in Dahej, there are worries that volume growth may be difficult to come by in the near-term. While these worries are justified to some extent, the recent fall in price provides a good opportunity for investors with a long-term perspective (around two to three years) to buy into the stock.

Filling the vacuum

The increasing substitution of imported LNG for declining domestic natural gas production, Petronet's ongoing expansion plans which should lead to capacity boost late next calendar, and the company's strong financials underpin our recommendation. At its current price of Rs 160, the stock trades at a reasonable 13.4 times its trailing twelve month earnings, lower than its historical levels.

Thanks to its cost advantage over fuels such as naphtha, diesel and LPG, the demand for natural gas in the country is running far ahead of supply, and the gap is set to widen in the coming years. The growing demand for the commodity from various sectors including power, fertilisers, refineries, petrochemicals, city gas distributors and sponge iron makers ensures that Petronet has for the most part a ready market for its wares. This is notwithstanding the relatively high cost of imported gas compared to that produced domestically.

Over the past year and half, gas output from the KG-D6 fields of Reliance Industries, which was expected to increase steadily, has instead been declining. This has led to many user industries turning to imported LNG to meet their existing and incremental requirements. Petronet has been able to make the most of this scenario.

In FY-11, the company's volumes increased by around 10 per cent. This along with better realisations and improved operational efficiency helped Petronet grow profits by around 53 per cent. In the first half of the current fiscal too, robust volume growth (around 38 per cent year-on-year) has contributed to the company more than doubling its profits to Rs 517 crore.

Growing demand translated into an increased quantum of spot cargoes, which in addition to regasification charges provide the company with marketing margins. Petronet expects spot cargo demand to remain buoyant in 2012 also, and has recently contracted to buy from GDF Suez (a shareholder in the company) 0.6 million tonnes of LNG.

Increased demand has led to Petronet operating its Dahej facility above nameplate capacity levels (105 to 108 per cent utilisation). While this may restrict volume growth in the near-term, the annual 5 per cent escalation on regasification charges on long-term contracts coming January should aid sales growth. Back-to-back long term purchase and sales arrangements account for bulk of the company's sales.

Expansion in progress

Meanwhile, Petronet's expansion plans at its Dahej plant (from 10 mtpa to 15 mtpa), and the greenfield project at Kochi (5mtpa) are in progress. The second terminal at Dahej, which should increase capacity to 12.5mtpa, is expected to be completed by October 2013, while the full expansion to 15 mtpa should be over by end-2015.

The Kochi plant is expected to be commissioned by October 2012. Besides, Petronet is also considering setting up a 5 mtpa LNG terminal on the East Coast. While the company currently has a long-term contract for sourcing 7.5 mtpa for its Dahej plant and has tied up 1.44 mtpa for the Kochi plant, it is in talks with players such as Qatar-based RasGas (existing supplier to Dahej plant) and Russia-based Gazprom to increase long-term supplies in the years ahead.

The gas pipeline network in the country is being expanded rapidly, led by players such as GAIL and GSPL. Currently under-served, high-potential regions such as South India are also being covered by the new pipelines. These should open up new markets for Petronet and aid utilisation of its expanded capacities.

The company's comfortable leverage position (debt-to-equity slightly above one) gives it leeway to borrow for its expansion plans.

Risks

There are concerns that the price of spot LNG, if it climbs steeply, as seen some time back, may result in its cost-competitiveness being eroded. This could dent demand and crimp Petronet's volumes. However, there has been moderation in spot LNG prices in recent times. Also, in the long-term, with contracts to source cheaper unconventional sources such as shale gas being entered into — GAIL's recent LNG sourcing deal with the US-based Cheniere Energy being a case in point — the cost of imported gas may remain reasonable. The competitive intensity in the LNG market in India is set to increase with the 2.5 mtpa Dabhol LNG terminal expected to be commissioned in 2012, and Indian Oil considering a 5 mtpa plant on the East Coast. Yet, Petronet with its first-mover advantage and expansion plans should be able to hold its own.

Finally, even if domestic gas production is stepped up in the coming years, and RIL ramps up production from the current 40 mmscmd to 90 mmscmd, the rapidly growing demand for natural gas (expected to be 381 mmscmd by 2015) will far exceed the projected domestic supply (203 mmscmd). This provides enough room for LNG players.

COMMENT NOW