GUJARAT STATE PETRONET a I D Nominal COVID-19 Downturn; Quick Revival

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GUJARAT STATE PETRONET a i d Nominal COVID-19 downturn; quick revival

n I India Equity Research| Oil, Gas and Services

Gujarat State Petronet (GSPL) is a pure gas pipeline utility, which is EDELWEISS RATINGS relatively less affected by the ongoing COVID-19 downturn. In fact, it is Absolute Rating BUY poised to resume a sustainable 4-5% long-term volume CAGR. It not only Investment Characteristics Growth enjoys a healthy balance sheet, enabling it to weather the current stress,

but also robust INR50bn FCF over FY21-23E will help it turn debt free. The

stock has fallen ~25% since February on concerns that its largest customer MARKET DATA (R: GSPT.BO, B: GUJS IN) Reliance Industries (RIL) will sharply cut volumes following start-up of its CMP : INR 186 own petcoke gasifier. RIL continues to source 9-10mmscmd of gas despite Target Price : INR 278 full commissioning of its plant during March 2020. Besides, COVID-19- 52-week range (INR) : 264 / 146 related volume hit is also currently limited to 13%, with an ongoing quick Share in issue (mn) : 564.1 recovery. Maintain ‘BUY’ with revised DCF-based TP of INR278 (INR290 M cap (INR bn/USD mn) : 103 / 1,525 earlier) due to cut in volume demand forecast. Avg. Daily Vol. BSE/NSE (‘000) : 584.1

Corona-related volume dip nominal; quick revival underway SHARE HOLDING PATTERN (%) We expect GSPL to report a nominal 3% QoQ volume dip during Q4FY20 and a further Current Q3FY20 Q2FY20 10% dip to 32mmscmd during Q1FY21, followed by a steady revival to normal level. We Promoters * 37.6 37.6 37.6

expect the halving of imported LNG prices to double offtake to 10mmscmd by the power MF's, FI's & BKs 33.9 33.9 33.9 sector, which will largely compensate for a sharp 7mmscmd fall in CGD offtake. FII's 15.9 15.9 15.5

Consumption at Morbi has plunged 90% to 0.5mmscmd, which is reviving strongly as Others 12.6 12.6 12.9 ceramic manufacturing activity is resuming. Furthermore, regulatory action from NGT * Promoters pledged shares : NIL (% of share in issue) can significantly increase volume offtake from Gujarat Gas in the medium term.

PRICE PERFORMANCE (%) Plentiful supply from new LNG, domestic gas for sustained growth BSE Midcap Stock over Stock With plentiful LNG supply to fulfill demand, GSPL is the sole offtaker for Mundra terminal Index Index (up 20% additional volumes) and the Dahej capacity expansion. We expect the Anjar- 1 month 16.2 13.1 (3.1) Chotila pipeline to add 9mmscmd capacity in FY21 as the Mundra LNG terminal ramps- 3 months (20.5) (16.8) 3.8 up operations, while the Dahej pipeline has started contributing to volumes. Moreover, 12 months (19.3) 4.6 24.0 parent company GSPC and Essar Group have contracted 70% of RIL’s upcoming KGD6 gas

(from June 2020), which will be transported through GSPL’s pipelines.

Outlook & valuation: Upcoming tariff cut risk; retain ‘BUY’

Given the recent sharp cut in corporate tax rate, the regulator is likely to cut tariffs shortly to ensure regulated ROIC, which may come as a surprise to some. After stripping-out value of its subsidiary Gujarat Gas, GSPL quotes at compelling PER of 3.0x FY22E. We maintain ‘BUY/SO’ with a revised DCF-based TP of INR278/share. Financials (INR mn) Jal Irani

Year to March FY19 FY20E FY21E FY22E +91 22 6620 3087 [email protected] Net revenue 93,451 118,404 94,868 115,292 EBITDA 25,402 33,103 28,700 32,859 Vijayant Gupta

Adjusted Profit 9,986 14,812 11,662 13,910 +91 22 4040 7402 [email protected] Adjusted diluted EPS (INR) 17.7 26.3 20.7 24.7

Diluted P/E (x) 10.5 7.1 9.0 7.5

EV/EBITDA (x) 6.1 4.7 5.4 4.8 ROAE (%) 31.4 36.8 23.3 17.0 May 18, 2020

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Oil, Gas and Services

Weak volume demand, but quick revival expected We expect GSPL to report a nominal volume at 32mmscmd during Q1FY21, followed by a steady revival to normal level. We expect the halving of imported LNG prices to double offtake to 10mmscmd by the power sector, which will largely compensate for a sharp 7mmscmd fall in CGD offtake.

Table 1: Volumes dip due to weak demand amid COVID-19 lockdown Vol. (mmscmd) Q4FY19 Q3FY20 Q4FY20E Q1FY20E FY21E Power 3.0 5.9 5.8 10.0 7.5 CGD 8.2 10.9 10.6 2.5 9.9 Refining / Petchem 12.1 12.0 11.7 11.5 9.3 Fertilizer 4.3 4.1 4.0 2.5 4.5 Steel 2.6 2.5 2.8 3.5 3.2 Others 2.2 1.5 1.2 2.0 2.1 Total 32.4 36.9 36.0 32.0 36.5 Source: Edelweiss research

Plentiful LNG supply at low spot LNG prices With plentiful LNG supply to fulfill demand, GSPL is the sole off-taker for both the Mundra terminal (+20% additional volumes) and the Dahej capacity expansion. Spot LNG will remain under pressure in the near term with the onset of weak demand amid COVID-19 and plentiful gas supply globally. With the upcoming new projects globally and new pipelines, capacity will surge to supply LNG all across. Moreover, RIL’s scheduled commissioning of KDG6 supplies from June 2020 will further add to gas volume availability.

Chart 1: Spot LNG prices have crashed to USD2.0/mmbtu in weak environment

15.0

12.0

9.0

6.0 (USD/ mmbtu) (USD/ 3.0 Spot LNG prices has crashed amid weak demand with oversupplied LNG

0.0

Feb/17 Feb/18 Feb/19 Feb/20 Feb/16

Aug/15 Aug/16 Aug/17 Aug/18 Aug/19

Nov/15 Nov/18 Nov/19 Nov/16 Nov/17

May/16 May/17 May/18 May/19 May/20 Spot LNG Price

Source: Edelweiss research

2 Edelweiss Securities Limited Gujarat State Petronet

Besides, over 70MT capacity will come on stream by 2021, thereby deepening the glut for the period. This will keep spot LNG muted, implying that downstream CGD companies will continue to benefit from the recent uptick in margin. Lower gas prices than alternative fuels will continue to spur gas demand, benefiting players across the gas value chain.

Fig. 1: Incremental LNG supply over CY19 and CY20E

Source: FGE, Edelweiss research

A glut in LNG capacity is expected to persist till 2021, leading to muted spot LNG prices. The anticipated return of tightness in LNG markets over 2022–25 will push up spot LNG prices before the next wave of very large LNG capacity adds kicks in post 2025.

Fig. 2: LNG capacity glut till 2021; slowing capacity adds to reignite deficit over 2022–25

Source: IGU, Edelweiss research

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Way forward for GSPL; growth outlook encouraging GSPL not only enjoys a healthy balance sheet with good cash position, but also when a company has good cash flows like GSPL, it can survive better. In this current scenario when demand gets lower due to lockdown stress, robust FCF of nearly INR50bn during FY21-23E will enable it to turn debt free with strong growth going forward when the country goes normal after the lockdown is lifted.

Table 2: Strong free cash flow through FY12-23E will turn GSPL debt free by FY23 (INR mn) FY19 FY20E FY21E FY22E FY23E Operating cash flow 20,442 27,769 22,280 27,815 29,878 Financing cash flow (13,822) (16,277) (12,555) (10,877) (14,415) Investing cash flow (6,117) (9,179) (11,252) (9,558) (8,202) Capex (7,541) (9,973) (11,663) (10,052) (8,863) Free Cash Flow 12,901 17,796 10,617 17,763 21,015 Net Debt 41,076 24,094 14,807 6,064 (12,619) Net debt/ Equity (x) 1.0 0.4 0.2 0.1 (0.1) Source: Edelweiss research

Though we forecast sustained growth, it is way below consensus As we trim our volume forecast, we have cut our EBITDA/ PAT by 3.4%/ 2.6% which is still 8.5%/0.4% discount to consensus for FY22.

Table 3: EBITDA/ PAT at 8.5%/0.4% discount to consensus for FY22 (INR mn) FY20E FY21E FY22E Edel 33,103 28,700 32,859 EBITDA Consensus 31,160 32,432 35,912 % change 6.2 (11.5) (8.5) Edel 14,812 11,662 13,910 PAT Consensus 14,829 14,863 13,967 % change (0.1) (21.5) (0.4) Source: Edelweiss research

Table 4: GSPL valued at 3.0x PER FY22E after stripping out its investments All figures in INR Mn Value Market cap of GSPL 104827 Market value of investments 81337 Market value of standalone business 23490 FY22E PAT 7790 Implied FY22 PER 3.0 Source: Company, Edelweiss research

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Table 5: Revised SOTP based TP to INR278/share Base value Base value (INR mn) (INR/share) Comments

Enterprise value of operating assets 71,606 127 DCF based on 11.5% WACC and 3.5% terminal growth rate Value of investments 1,01,672 180 Gujarat Gas 98,432 175 Based on 54% stake; 20% holdco discount Sabarmati Gas 3,240 6 Based on 27.47% stake and 15x FY22 PER Net Debt 16,851 30 Equity value 1,56,427 278 CMP (INR) 186 Upside (%) 49% Source: Company, Edelweiss research

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Company Description Gujarat State Petronet (GSPL), a group entity of the GSPC group, is currently a Gujarat focused natural gas transmission firm operating on an open access basis. It owns approximately 2,500 km natural gas pipeline transporting ~36 mmscmd of gas. To increase its geographical spread it had participated and won bids to put up 3 major pipelines outside Gujarat (1) Mallavaram (Andhra Pradesh) - Bhilwara (Rajasthan), (2) Mehsana (Gujarat) - Bhatinda (Punjab), and (3) Bhatinda (Punjab) - Srinagar (J&K). GSPL owns stake in two city gas distribution firms – Sabarmati Gas and Gujarat Gas. It is the second largest gas pipeline player in the country after GAIL.

Investment Theme GSPL faces potential tailwinds, with its gas transmission volumes poised to rise on top priority allocation to city gas distribution. GSPL holds stake in 2 city gas geographies, which account for one-third of its volume offtake.

Key Risks GSPL is likely to suffer from lower capacity utilisation due to limited availability of gas.

Any cut in transmission tariffs can lead to a downward revision in earnings. The company’s profitability and thus its ROE’s can be majorly impacted due to cut in tariffs.

The three new pipelines can get delayed due to land availability issues, leading to losses.

6 Edelweiss Securities Limited Gujarat State Petronet

Financial Statements

Key Assumptions Income statement (INR mn) Year to March FY19 FY20 FY21E FY22E Year to March FY19 FY20 FY21E FY22E Macro Net revenue 93,451 118,404 94,868 115,292 GDP(Y-o-Y %) 6.1 4.8 0.0 6.0 Materials costs 57,967 73,334 54,309 69,147 Inflation (Avg) 3.4 4.3 3.5 4.0 Gross profit 35,484 45,070 40,558 46,145 Repo rate (exit rate) 6.3 4.4 3.0 4.0 Employee costs 2,245 2,565 2,901 3,338 USD/INR (Avg) 70.0 70.7 75.0 73.0 Operating expenses 7,837 9,403 8,958 9,948 Company EBITDA 25,402 33,103 28,700 32,859 Operational assumptions Depreciation 4,680 5,265 5,802 6,312 Volume trans (mmscmd) 34.6 38.2 36.5 38.3 EBIT 20,723 27,837 22,898 26,547 Financial assumptions Less: Interest Expense 4,269 3,410 2,588 2,100 Trans tariff (INR/scm) 1.5 1.5 1.2 1.3 Add: Other income 1,381.19 793.9 411.1 494.21 Employee exp. (%yoy inc) 49.4 12.0 8.0 15.0 Profit Before Tax 17,834 26,504 20,721 24,941 Admin exp (y/y % change) 20.8 20.0 5.0 5.0 Less: Provision for Tax 5,900 6,348 5,216 6,278 O&M exp (% revenues) 12.4 14.4 18.1 16.9 Less: Minority Interest 1,918 4,231 4,040 4,980 Interest(% of Avg loans) 8.1 8.0 8.0 8.0 Add: Exceptional items - 1,283 - - Ot inc (% cash+inv) 22.7 15.0 15.0 15.0 Associate profit share 149 171 196 226 Dep (% of Avg GFA) 4.5 4.7 4.7 4.7 Reported Profit 10,165 16,095 11,662 13,910 B/S assumptions Exceptional Items 179 1,283 - - Tax rate (%) 34.5 25.2 25.2 25.2 Adjusted Profit 9,986 14,812 11,662 13,910 Capex (INR mn) 2,165 4,216 5,635 4,054 Shares o /s (mn) 564 564 564 564 Debtor days 11 11 11 11 Adjusted Basic EPS 17.7 26.3 20.7 24.7 Inventory days 7 7 7 7 Diluted shares o/s (mn) 564 564 564 564 Loans & adv (% net rev) 1.6 1.6 1.6 1.6 Adjusted Diluted EPS 17.7 26.3 20.7 24.7 CL (% WIP) 53.9 53.9 53.9 53.9 Adjusted Cash EPS 27.3 35.6 31.0 35.9 Dividend per share (DPS) 2.0 2.6 1.8 2.1 Dividend Payout Ratio(%) 11.1 9.0 8.6 8.4

Common size metrics Year to March FY19 FY20 FY21E FY22E Materials costs 62.0 61.9 57.2 60.0 Staff costs 2.4 2.2 3.1 2.9 S G & A expenses 8.4 7.9 9.4 8.6 Operating expenses 10.8 10.1 12.5 11.5 Depreciation 5.0 4.4 6.1 5.5 Interest Expense 4.6 2.9 2.7 1.8 EBITDA margins 27.2 28.0 30.3 28.5 Net Profit margins 10.7 12.5 12.3 12.1

Growth ratios (%) Year to March FY19 FY20 FY21E FY22E Revenues 28.7 26.7 (19.9) 21.5 EBITDA 24.3 30.3 (13.3) 14.5 PBT 22.8 48.6 (21.8) 20.4 Adjusted Profit 34.7 48.3 (21.3) 19.3 EPS 34.7 48.3 (21.3) 19.3

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Balance sheet (INR mn) Cash flow metrics As on 31st March FY19 FY20 FY21E FY22E Year to March FY19 FY20 FY21E FY22E Share capital 5,640 5,640 5,640 5,640 Operating cash flow 20,442 27,769 22,280 27,815 Reserves & Surplus 27,313 41,674 52,133 63,644 Financing cash flow (13,822) (16,277) (12,555) (10,877) Shareholders' funds 32,952 47,314 57,773 69,284 Investing cash flow (6,117) (9,179) (11,252) (9,558) Minority Interest 10,108 13,227 16,459 20,443 Net cash Flow 502 2,313 (1,527) 7,381 Long term borrowings 33,747 26,746 20,746 15,546 Capex (7,541) (9,973) (11,663) (10,052) Short term borrowings 12,044 9,100 8,100 8,100 Dividend paid (1,796) (1,734) (1,203) (1,402) Total Borrowings 45,791 35,846 28,846 23,646

Long Term Liabilities 1,639 1,083 1,063 1,203 Profitability and efficiency ratios Def. Tax Liability (net) 16,297 12,683 12,679 12,944 Year to March FY19 FY20 FY21E FY22E Sources of funds 106,786 110,153 116,819 127,520 ROAE (%) 31.4 36.8 23.3 17.0 Gross Block 105,782 102,737 110,520 117,614 ROACE (%) 19.0 23.3 17.7 25.0 Net Block 84,233 83,358 85,972 87,668 Inventory Days 7 6 7 6 Intangible Assets 4,742 4,568 4,615 4,656 Debtors Days 23 23 27 22 CWIP (incl. intangible) 9,082 11,407 10,988 13,168 Payable Days 13 12 15 12 Total net fixed assets 98,057 99,333 101,576 105,492 Cash Conversion Cycle 18 17 20 16 Non current investments 5,883 6,054 6,251 6,477 Current Ratio 1.2 1.2 1.5 1.9 Cash and Equivalents 4,715 11,752 14,039 17,581 Gross Debt/EBITDA 1.8 1.1 1.0 0.7 Inventories 1,973 2,009 1,758 2,033 Gross Debt/Equity 1.1 0.6 0.4 0.3 Sundry Debtors 7,003 7,951 6,325 7,601 Adjusted Debt/Equity 1.1 0.6 0.4 0.3 Loans & Advances 939 1,013 409 571 Net Debt/Equity 1.0 0.4 0.2 0.1 Other Current Assets 6,044 8,599 5,454 5,999 Interest Coverage Ratio 4.9 8.2 8.8 12.6 Total current assets 15,959 19,572 13,945 14,850

Trade payable 3,615 4,373 3,357 4,239 Operating ratios Other Current Liab 14,213 22,185 15,634 12,641 Year to March FY19 FY20 FY21E FY22E Total Current Liab 17,828 26,558 18,991 16,880 Total Asset Turnover 0.9 1.1 0.8 0.9 Net Curr Assets-ex cash (1,869) (6,986) (5,046) (2,030) Fixed Asset Turnover 1.1 1.3 1.1 1.3 Uses of funds 106,786 110,153 116,819 127,520 Equity Turnover 3.3 3.0 1.8 1.8 BVPS (INR) 58.4 83.9 102.4 122.9

Valuation parameters

Free cash flow (INR mn) Year to March FY19 FY20 FY21E FY22E Year to March FY19 FY20 FY21E FY22E Adj. Diluted EPS (INR) 17.7 26.3 20.7 24.7 Reported Profit 10,165 16,095 11,662 13,910 Y-o-Y growth (%) 34.7 48.3 (21.3) 19.3 Add: Depreciation 4,680 5,265 5,802 6,312 Adjusted Cash EPS (INR) 27.3 35.6 31.0 35.9 Deferred tax 2,857 2,593 1,936 1,571 Diluted P/E (x) 10.5 7.1 9.0 7.5 Others 3,790 4,429 2,227 6,550 P/B (x) 3.2 2.2 1.8 1.5 Less: Changes in WC 1,050 615 (652) 528 EV / Sales (x) 1.7 1.3 1.6 1.4 Operating cash flow 20,442 27,769 22,280 27,815 EV / EBITDA (x) 6.1 4.7 5.4 4.8 Less: Capex 7,541 9,973 11,663 10,052 Dividend Yield (%) 1.1 1.4 1.0 1.1 Free Cash Flow 12,901 17,796 10,617 17,763 EV 156,082 156,082 156,082 156,082

Peer comparison valuation Market cap Diluted P/E (X) EV / EBITDA (X) ROAE (%) Name (USD mn) FY21E FY22E FY21E FY22E FY21E FY22E Gujarat State Petronet 1,360 8.8 7.4 4.7 3.9 23.3 17.0 GAIL (INDIA) 5,133 6.8 5.3 6.3 4.7 10.9 12.9 Indraprastha Gas 4,272 23.4 19.7 16.6 13.6 24.3 24.6 Median - 8.8 7.4 6.3 4.7 23.3 17.0 AVERAGE - 13.0 10.8 9.2 7.4 19.5 18.2 Source: Edelweiss research

8 Edelweiss Securities Limited Gujarat State Petronet

Additional Data Directors Data Dr. J.N.Singh, IAS Managing Director Prof. Yogesh Singh Independent Director Dr. Bakul Dholakia Independent Director Shridevi Shukla Woman Independent Director Dr. Sudhir Kumar Jain Independent Director Bhadresh Mehta Independent Director MANMOHAN SRIVASTAVA Independent Director ARVIND MOTILAL AGARWAL Independent Director PANKAJ HARISHCHANDRA JOSHI Independent Director

Auditors - RMA & Associates *as per last available data

Holding – Top10 Perc. Holding Perc. Holding

No Data Available

*as per last available data

Bulk Deals Data Acquired / Seller B/S Qty Traded Price

No Data Available

*as per last available data

Insider Trades Reporting Data Acquired / Seller B/S Qty Traded

No Data Available

*as per last available data

9 Edelweiss Securities Limited Oil, Gas and Services

Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai – 400 098. Board: (91-22) 4009 4400, Email: [email protected]

Aditya Narain Head of Research [email protected]

Coverage group(s) of stocks by primary analyst(s): Oil, Gas and Services Bharat Petroleum Corporation, GAIL (INDIA), Gujarat Gas, Gujarat State Petronet, Hindustan Petroleum Corporation, Indraprastha Gas, Indian Oil Corporation, Mahanagar Gas Ltd, ONGC, Petronet LNG, Reliance Industries ` Recent Research Date Company Title Price (INR) Recos 11 -May-20 Bharat Deep value follows deep 325 Buy Petroleum impact; Corporation Company Update 01-May-20 Reliance ‘Right’ on track to zero net 1,464 Buy Industries debt; Result Update

22-Apr-20 Reliance Value unlocking, deleveraging 1,250 Buy Industries with Facebook stake; Sector Update

Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Rating Interpretation

Buy Hold Reduce Total Rating Expected to Rating Distribution* 161 67 11 240 Buy appreciate more than 15% over a 12-month period * 1stocks under review Hold appreciate up to 15% over a 12-month period > 50bn Between 10bn and 50 bn < 10bn Reduce depreciate more than 5% over a 12-month period Market Cap (INR) 156 62 11

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Edelweiss Securities Limited 10

Gujarat State Petronet

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