Petronet LNG: BUY

Over the past three months, even as the Sensex gained 7.9 per cent, the stock of gas importer and regasifier Petronet LNG lost more than 7 per cent. This, despite the company posting good results over the past few quarters by capitalising on increasing demand for natural gas in India amid decline in domestic production.

Fears of a possible cap on the company’s marketing margin have also receded. But market sentiment towards the stock seems to have been impacted by the delay in commissioning of Petronet’s new 5 mtpa terminal in Kochi, Kerala.

Capacity ramp-up at the Kochi terminal is expected to be slower than initially expected, due to likely delay in gas pipeline connectivity to end users.

Currently, Petronet is operating above capacity at its mainstay 10 mtpa terminal in Dahej, Gujarat. So, future volume growth will kick in only after the new terminal in Kochi commences operations and expansion at the Dahej plant takes shape.

Volume growth expected

Despite the near-term volume growth concerns, the current weakness in the stock presents a good buying opportunity for investors with a two-to-three year perspective.

At its current price of Rs 154, the Petronet stock discounts its trailing 12-month earnings by around 10 times, lower than the levels it has traded at in the past (13 to 15 times). Also, volume growth, though delayed, should happen sooner than later.

The Kochi terminal is expected to be commissioned in April this year. While utilisation at this plant is expected to be low initially (around 10 per cent in the first year), it is expected to rise gradually over the next two-three years with the completion of an extended pipeline network by GAIL in South India and increased off-take by end users.

Also, by the end of this calendar or early next year, the second jetty at Dahej is expected to be completed, which should increase the terminal’s capacity to around 12.5 mtpa. Full expansion of the Dahej terminal expected in FY-15 should increase its nameplate capacity to around 15 mtpa.

Petronet has tied up long-term contracts with GAIL and GSPC for around three-fourth of the proposed expansion in capacity at the Dahej terminal. This provides good revenue visibility.

The company has also initiated work on setting up a 5 mtpa terminal in the East Coast at Gangavaram, Andhra Pradesh.

While this project may take a few years (up to FY16) to complete, Petronet is looking at the possibility of setting up a floating storage and re-gasification unit (FSRU) by the end of this calendar to commence supplies.

Demand for natural gas in India is strong and growing, thanks to its cost advantages over alternative fuels.

But with domestic supplies falling rapidly due to declining output from the KG-D6 fields of Reliance Industries, the dependence on imported gas has been increasing.

Petronet, which controls around 70 per cent of the gas imports into the country, has benefited from this, and has consistently operated its Dahej plant at more than 100 per cent of capacity levels.

The recent December quarter was also a healthy one for the company with 110 per cent capacity utilisation. More than three-fourths of Petronet’s revenues come from long-term fixed contacts.

The company increases re-gasification charges on these contracts by 5 per cent every year in January. The latest round of hikes, which would have happened this month, will aid revenues in the near-term.

Petronet also earns marketing margins on spot cargoes, volumes of which have remained healthy. The company should be able to sustain volumes, unless spot liquefied natural gas (LNG) prices increase sharply and make imports uncompetitive.

By 2015, the demand for natural gas in India (more than 430 mmscmd) is expected to be far ahead of domestic supply (around 200 mmscmd).

This should provide enough room for LNG importers in the country such as Petronet.

In this context, competition in the form of expansion (by 1.5 mtpa) of the Shell-operated Hazira terminal and the new 5 mtpa GAIL-operated Dabhol terminal should not impact Petronet’s prospects. Even if domestic gas supply grows faster than expected, there should be adequate demand for gas imports.

Strong financials

In the December quarter, Petronet’s profits grew around 7.8 per cent year-on-year and 1.2 per cent sequentially, thanks to better marketing margins and higher capacity utilisation.

As on September 30, the company’s debt-to-equity stood at a reasonable 0.7 times, providing it adequate leeway to raise funds for expansion plans.

In the near-term, high depreciation and interest expenses may weigh on the company’s financials, but long-term profitability prospects seem sound.

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