>SWITCH STRATEGY: Gujarat State Petronet Limited to Petronet LNG

■ Indian market starved of natural gas
The Indian market has always suffered from a chronic shortage of natural gas supplies. While a study by Mercados shows that natural gas demand is expected to grow at CAGR of 21% from 179 mmscmd in FY11 to 381 mmscmd in FY15, DGH estimates that supply will grow at CAGR of only 8.6% from 146 mmscmd in FY11 to 203 mmscmd in FY15. This is due to limited domestic gas supplies, gas pricing & customer allocation being the prerogative of the Govt. and inadequate transmission infrastructure in the country. The producing fields of ONGC and OIL are highly mature and positive production surprises are not expected in the near term. KG D6, which was expected to ramp up to 80 mmscmd, is languishing at ~40 mmscmd currently.


■ Transmission volumes to suffer consequently – GSPL remains vulnerable
The KG D6 block, from which 58% of GSPL’s transmission volume was sourced in FY11, is in natural decline with the latest production figure at 39.8 mmscmd, compared to 46.6 mmscmd & 55.9 mmscmd in H1 FY12 & FY11 respectively. With the KG D6 block stuck in a political quagmire, output is set to decline further resulting in lower D6 volumes for GSPL. As PLNG’s Dahej terminal is already operating above its rated capacity, further upside to LNG volumes appears less likely.


■ Reduction of transmission tariff looms large
Along with falling volumes, the spectre of tariff cut also is looming large. GSPL charged transmission tariff of Rs 0.79/scm & Rs 0.82/ scm in FY11 & H1 FY12 respectively and correspondingly generated ROCE of 26% & 28%. This is much higher than the normative ROCE of 18% allowed by the regulator. Hence, we expect the tariff to be revised downward to Rs 0.75/scm from FY13 onwards.


■ Imported LNG the only bright spot – PLNG best positioned
Significant shortfall in domestic gas supply, active sourcing of LNG contracts and first mover advantage combine to position Petronet LNG as an attractive investment opportunity. It enjoys the first mover advantage with its 10 MMTPA LNG terminal at Dahej. The company is taking advantage of the favorable economics of this industry by doubling its capacity to 20 MMTPA by end-FY15. In light of limited supplies of cheap domestic gas being earmarked for the priority sector’s growing needs, we expect companies operating in the steel, refinery/petchem, sponge iron etc. to increasingly turn to R-LNG. Moreover, R-LNG is environment-friendly and cheaper than its competing fuels, namely, naphtha, diesel and fuel oil.


■ Valuation
We rate GSPL as UNDERPERFORMER and assign a target price of Rs 77 (1 yr fwd P/E: 10x) which translates into downside of 12%. We reiterate BUY on Petronet LNG and assign a target price of Rs 204 which translates into upside of 28%.


To read the full report: SWITCH STRATEGY
RISH TRADER