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

s p COMPANY UPDATE a c d i M 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 Edelweiss Research is also available on www.edelresearch.com, Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Edelweiss Securities Limited 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 3 Edelweiss Securities Limited Oil, Gas and Services 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 4 Edelweiss Securities Limited Gujarat State Petronet 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 5 Edelweiss Securities Limited Oil, Gas and Services 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.

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