Investors with a long-term perspective can consider buying the stock of gas transmitter Gujarat State Petronet (GSPL). Easing fears on tariff regulation, cooling down of imported gas price which should aid volumes, prospects of improved gas supplies over the next two-three years and attractive valuation support the recommendation. At Rs 82, the GSPL stock trades at around nine times its trailing 12-month earnings, lower than levels it had traded in the past (around 13-15 times).

Regulatory worries ease

The natural gas sector has been battling regulatory uncertainty for the past few months. This was after downstream regulator, PNGRB, in April, directed Delhi-based Indraparastha Gas to slash its network tariff and compression charge by almost 60 per cent. This took a toll on sentiment across the sector.

The stocks of most gas companies, including GSPL, took a beating, on fears that they too may be on the regulator’s radar. In the case of GSPL, the regulator issued a direction last month reducing tariffs for pipelines comprising the majority of the company’s network. But the extent of the cut (effectively 12.5 per cent with retrospective effect from November 2008) has been lower than apprehended.

The company will have to take a one-time hit of around Rs 200-300 crore. But importantly, this direction removes a major overhang on the GSPL stock. If at all, the company may appeal against the regulator’s order. The focus will now return to GSPL’s core business.

Business outlook

On the operational front too, there has little to write home about over the past few quarters. GSPL’s transmission volumes have been stagnant or declining.

This is mainly due to the continuous decline in domestic gas supply from the KG-D6 fields of Reliance Industries. Also, the high price of imported gas (spot liquefied natural gas was trading in the range of $15-$16 per mmbtu) resulted in low off-take from customers and lower transmission volumes for GSPL.

The combination of regulatory risk and lacklustre operational performance saw the GSPL stock lose heavily on the bourses. Despite recent gains, it still trades almost 25 per cent below its September 2011 levels.

But things may look up for GSPL on the volumes front. The price of spot LNG has moderated in recent months to $10-$11 per mmbtu. This should translate into increased interest for imported gas. In this context, the recent sharp appreciation in the rupee also helps.

Demand for natural gas in the country runs far ahead of supply. With the capacity of existing LNG terminals at Dahej and Hazira being increased and new terminals such as Kochi expected to be commissioned over the next two to three years, the supply of LNG in the country should increase. This bodes well for GSPL. Any improvement in domestic supplies will be a bonus.

Expansion plans

Besides growing its 1,960 km pipeline network in Gujarat, GSPL is also expanding outside the State. A consortium led by GSPL is executing three cross-country gas pipelines — Mallavaram-Bhilwara-Vijaipur, Mehsana-Bhatinda and Bhatinda-Srinagar — aggregating around 4,000 km. While GAIL (India) has challenged the award of the Mallavaram-Bhilwara-Vijaipur pipeline to GSPL, the court has allowed the latter to continue work pending further decisions.

On completion of these pipelines in the next three to four years, GSPL’s transmission capacity will expand by around 90 mmscmd.

The company’s currently has capacity of around 35 mmscmd. But capital spend on the new pipelines will increase depreciation and interest expenditure and may subdue profit growth till the pipelines commence operation.

Financial position

GSPL’s financial performance has been under pressure over the last few quarters. Its profits declined around 14 per cent year-on-year in the March quarter and by 9 per cent in the June quarter. But despite this, its operating margin at above 90 per cent and net margin at above 45 per cent remain healthy.

These provide cushion to absorb the new reduced tariffs. Also, the company’s financial position is robust. Its debt-to-equity at 0.4 times and cash balance of more than Rs 500 crore as on March 2012 provide headroom to fund expansion plans.

Last week, GSPL’s parent company Gujarat State Petroleum Corporation (GSPC) acquired controlling stake in city gas distributor Gujarat Gas.

GSPL has been named as one of the ‘persons acting in concert’ for the open offer. Over the long term, this acquisition could benefit GSPL through increased demand and higher volumes of gas transmitted.

Risks

Risks to the recommendation include another sharp spike in the price of imported gas which could impact volumes. An adverse ruling in the cross-country pipeline dispute will hamper expansion plans. Also, availability of adequate gas by the time the expansion plans fructify will be crucial.

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