Sound business
The Gujarat government, through GSPC and other state-owned companies, holds 49.2 per cent stake in GSPL. Established to set up a natural gas transmission network in the state of Gujarat, GSPL has till date commissioned a pipeline network of 1,130 kilometers (kms) and has another 500 kms under construction. In addition, about 400-500 kms is in the planning stage. GSPL provides its gas transmission infrastructure on an ‘open access’ basis, which means the transmission capacity is available to any player on a non-discriminatory basis for a fee. For long-term transmission agreements, the contract period typically varies between 5-25 years, while a small chunk of the company’s revenues also flows from short-term contracts. Thus, the company generates a steady income from its business, barring situations where gas transmission volumes fall.
Output boost
GSPL’s gas transmission volumes are seen increasing from about 16 mmscmd (million metric standard cubic metre per day) currently to a little over 20 mmscmd in FY10. The company has already signed a 20-year agreement with Torrent Power to supply around 5 mmscmd of gas for the latter’s 1,150 MW power plant. This plant is expected to go on stream in phases from April 2009, wherein gas supplies will be scaled up from the initial requirement of about 2 mmscmd.
Likewise, an agreement with RIL is also in place, which will see GSPL transmit about 11 mmscmd of gas from the entry point in Gujarat to RIL’s Jamnagar complex. However, analysts say that since the Gas Utilisation Policy announced by the government (where the initial 40 mmscmd has been reserved for allocation to the power and fertiliser sectors) is silent on allocation of gas for internal consumption, the 11 mmscmd gas supplies to RIL may start only by end-FY10. This is also assuming that RIL will commence production from its KG-basin by March 2009, wherein the initial production will be scaled up from 5-10 mmscmd to 40 mmscmd by end-2009 and to 80 mmscmd in FY11.
Nevertheless, by FY11, expect gas transmission volumes of GSPL to nearly double to 31-32 mmscmd. The additional boost may also come from the commissioning of new LNG regassification (RLNG) capacity of Petronet LNG by around October 2009.
| STEADY GAS FLOW | ||||
| in Rs crore | FY08 | FY09E | FY10E | FY11E |
| Revenues | 418 | 464 | 653 | 916 |
| PBT * | 149 | 115 | 171 | 267 |
| Net profit | 100 | 76 | 106 | 190 |
| EPS (Rs) | 1.69 | 1.35 | 1.91 | 3.38 |
| PE (x) | 19.64 | 24.59 | 17.38 | 9.82 |
| P/BV (x) | 1.64 | 1.57 | 1.49 | 1.44 |
| * Profit before tax after contribution to GSEDS E: Analysts estimates | ||||
That apart, analysts indicate that GSPL should also benefit from the implementation of new tariff guidelines (effective April 2010) announced by the regulator (Petroleum and Natural Gas Regulatory Board) for gas transmission services. Since these new rules allow a return on capital employed of 18 per cent on pre-tax basis, GSPL stands to gain as its current tariffs yield a lower return of about 15-16 per cent (adjusted for higher depreciation rate charged by GSPL). Thus, they expect overall returns for GSPL to improve from FY11 onwards.
Concerns
In the recent past, price of alternative feedstock like Naphtha had fallen sharply due to a weak demand outlook. Analysts believe that this could have led to some customers (with dual-feedstock capabilities) opting for the alternative feedstock, and thus, the decline in GSPL’s volumes of spot RLNG in Q3 FY09. However, the impact on financials was far lower (y-o-y growth of 6 per cent in revenues and 9 per cent in profit in Q3) due to ‘take or pay’ agreement with customers, wherein the latter is required to pay even if the offtake is lower. Analysts see this volume decline as an aberration. Also, naphtha prices have risen lately, rendering RLNG competitive. Thus, they expect RLNG volumes to pick up in Q4 with a visible improvement from Q1 FY10.
Secondly, the Gujarat government’s request to its state-owned companies to contribute up to 30 per cent of their pre-tax profits towards GSEDS, came in July 2008. In case of GSPL, on February 2, 2009, shareholders approved the contribution of Rs 64.40 crore for FY09 to GSEDS. However, analysts had already cut their estimates for FY09 EPS to Rs 1.35. Likewise, the EPS for FY10 and FY11 has been accordingly lowered, assuming the contribution to GSEDS. But, despite the special payout, GSPL’s EPS is expected to more than double by FY11, which in itself is considerable.
Investment rationale
Despite some glitches in the recent past and the expected payouts to GSEDS, GSPL’s prospects look good due to the expected increase in transmission volumes and requisite investment in capacity expansion. Since it is not involved in trading of gas, there is no risk in terms of price movements.
Secondly, the boost from higher returns on capital invested in the business will provide further kicker to GSPL’s earnings from FY11 onwards. The macro outlook, too, is conducive given India’s huge appetite for cleaner fuels like natural gas, which should get a boost from new discoveries by RIL, ONGC, GSPC and others, going ahead.
Importantly, GSPL operates in the country’s most industrialised state, Gujarat, which incidentally is the largest consumer of natural gas accounting for a third of India’s consumption—demand for natural gas in Gujarat is seen rising to 95-100 mmscmd by 2010 from about 60 mmscmd currently. Thus, expect GSPL to clock healthy volume growth in its core gas transmission business over the next 3-5 years at least. The company’s long-term investment, in the form of small stakes in two companies setting up city gas distribution network in Gujarat, is also seen as value accretive. At Rs 33.20, the stock trades at a price-to-estimated FY10 book-value of 1.5 times, and can deliver 18-20 per cen in a year’s time.
BUSINESS:
GSPL's 1,130-km pipeline network is spread across the state of Gujarat and connects natural gas producers on the west coast of Gujarat to their clients in nearly 33 districts of Gujarat. Some of GSPL's prominent clients are Gujarat Power, Essar Steel, Essar Power, Arvind Mills, GNFC and GSFC. The company operates its pipeline network on an open access basis and is not involved in buying and selling gas.
GROWTH FACTORS:
Presently, GSPL transports about 17 million metric standard cubic metres of gas a day (MMSCMD), which will double once its contracts with RIL and Torrent Power become effective. GSPL has signed a 15-year agreement with RIL to transport 11 MMSCMD and another contract with Torrent Power to transport 4.5 MMSCMD for 20 years. Torrent Power's 1,147.5 MW Sugen power plant is scheduled to commence operations in the quarter ending March 2009.
In the same quarter, RIL is also slated to start production of natural gas from the KG basin. The company is extending its pipeline network to 2,000 km by 2010 at a capex of Rs 1,900 crore. With the Petroleum and Natural Gas Regulation Board (PNGRB ) now in place, the company will get competitive advantage while bidding for new projects in the adjacent areas. GSPL's return on capital is low at present.
So, there is little risk that GSPL will have to reduce transport tariffs in future. GSPL also holds strategic stakes in gas distribution companies in three cities-two in Gujarat and one in Andhra Pradesh. Over the next two years, the availability of natural gas in India is expected to double. Apart from RIL's gas, Petronet LNG's project to double its regassification capacity to 10 million tonnes per annum is likely to be completed in January 2009.
FINANCIALS:
The natural gas transported by the company grew 17% from 14.6 MMSCMD in FY '07 to 17.1 MMSCMD in FY '08 but has stagnated since then. This is mainly due to the stagnation in the availability of natural gas and situation is likely to improve in the near future. The company has consistently increased its revenues per unit of gas transported. The company is currently carrying a debt of around Rs 1,200 crore at an average cost of 9.5%. The company has been consistently generating healthy cash flows from operating activities.
Being capital intensive, interest and depreciation are the most important costs for the company, which grew at a CAGR of 33.7% and 42.3%, respectively, in the last five years. During the same period its net sales grew at a CAGR of 31.4% and pre-tax profit grew at 70.3%.
GSPL currently assumes 12 years of working life, which increases the annual depreciation charged on its pipelines compared to 30 years working life assumed by India's largest gas transporter GAIL. This indicates the need to examine GSPL's cash profits rather than its book profits for its valuation. The company's cash profits have grown at a CAGR of 58.6% in last five years.
VALUATIONS:
The company is likely to post a 21% increase in its gas volumes in the second half of FY '09 to 20.6 MMSCMD. This will drive its H2 FY '09 revenues 36% up on y-o-y basis to Rs 309 crore. The net profit for the period is expected to go up 40% to Rs 91.8 crore. As a result, the company is expected to end FY '09 with an EPS of Rs 2.7 and cash EPS of Rs 5.8. The current price of Rs 34.8 translates this to a P/E of 12.7 based on book EPS and just 6, if we consider the cash EPS.
KEY RISKS:
The company is currently conducting a postal ballot seeking shareholders' view to contribute 30% of pre-tax profits for social development as requested by the chief minister of Gujarat. Presently, 50.2% of the company's equity capital is held by five companies, which are controlled by the Gujarat State government. The company's EPS will erode proportionately, if its shareholders accept the resolution.
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