Petronet LNG Upside/(Downside) (%) 31 Bloomberg Ticker PLNG in BUY Oil & Gas | India Market Cap

Institutional Equity Research CMP (Rs) 256 Petronet LNG Upside/(Downside) (%) 31 Bloomberg Ticker PLNG IN BUY Oil & Gas | India Market Cap. (Rs bn) 383 2 Year Target Price: Rs.335 Free Float (%) 50 Company Update | 17 July 2020 Shares O/S (Mn) 1,500

Strong Earnings Visibility; Attractive Valuation

Key Triggers:  India’s largest LNG re-gasification company with total operational capacity of 22.5MMTPA  Dahej, India’s biggest re-gas terminal well-connected with gas pipelines, operated at ~105% Click Image for Video capacity in FY20 Presentation   Global LNG prices slumped to multi-year low – positive  Kochi-Mangalore pipeline commissioning in Jul’20 – key growth driver  High dividend payout track record; strong cash rich balance sheet Research Analyst: Yogesh Patil 1. The drop in the global oil price is structurally positive for Petronet LNG (PLNG), as all its long- Contact : (022) 3303 4632/9763153797 term LNG contracts are oil-linked. So, a lower oil price scenario brings down its energy cost as Email : [email protected] well as reduces the premium of long-term contracts over the spot prices. Research Associate: 2. Kochi-Mangalore pipeline is expected to be commissioned by Jul’20, following which the Pratik Oza utilisation of Kochi terminal will increase to 22% in FY21E (with 28% YoY growth in volume) from Contact : (022) 3303 4000 / 9960358990 17% in FY20. Improved utilisation in Kochi will aid ~5% CAGR in earnings through FY20-FY23E.. Email : [email protected] 3. Mundra LNG terminal, which started operations in 3QFY20, is charging re-gas tariff of ~Rs63/ mmbtu compared to Rs52.4/mmbtu charged by Dahej terminal. So, any new player cannot offer any long-term contract at cheaper tariff than PLNG’s Dahej terminal. 4. PLNG is planning to set up LNG stations in phases. In Phase-I, it is setting up 50 stations on 5 major highways (western and southern corridor) in FY21E. In Phase-II, it plans to set up around 300 LNG dispensing stations on the highways. Annual running cost of LNG-fuelled truck is Share price (%) 1 mth 3 mth 12 mth estimated to be 38% cheaper than diesel-operated trucks with payback period of <2 years. Absolute performance 1.9 25.2 8.8 Relative to Nifty -6.3 6.3 18.0 Impact of COVID-19: Following drop in utilization level to 55%-60% in Apr’20, Dahej is now operating at 100% utilization level. PLNG has invoked force majeure clause on 1 LNG cargo, 7 Shareholding Pattern (%) Dec-19 Mar-20 Ras-gas cargoes and 1 Gorgon cargoes in Mar’20. While the LNG off-take by the power has Promoter 50.0 50.0 gone up in Gujarat, Torrent Power plant is consuming more spot LNG. Public 50.0 50.0 Outlook & Valuation We downwardly revise our EBITDA estimate by 21%/4% and PAT estimate by 31%/14% for FY21E and FY22E to factor the impact of COVID-19 in FY21 and a conservative scenario for FY22. We 1 Year Stock Price Performance believe PLNG offers an attractive combination of strong earnings visibility over the next 2 to 3 290 years, attractive valuation at 15.6x of FY23E EPS and strong cash rich balance sheet. Valuing on 270 DCF methodology with WACC of 10% and terminal growth rate of 0%, we maintain BUY on 250

PLNG with a 2-Year Target Price of Rs335. 230

210 Financial Summary 190 Y/E March (Rs.mn) FY19 FY20 FY21E FY22E FY23E 170 Net Sales 3,83,954 3,54,520 2,38,001 2,92,294 3,45,859 150 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 ------EBITDA 32,935 39,895 37,096 46,749 50,985 ------Jul Jul Oct Oct Sep Dec Jun Nov Jan Jan Apr Feb Aug Aug Mar Mar May EBITDA margin (%) 8.6% 11.3% 15.6% 16.0% 14.7% May Net Profit 22,306 27,034 21,827 28,961 32,248 Note: * CMP as on 16 July 2020 EPS(Rs.) 14.9 18.0 14.6 19.3 21.5 YoY growth (%) 6% 21% -19% 33% 11% Change of Estimates RoE (%) 22% 24% 19% 23% 23% (% change) FY21E FY22E RoCE (%) 23% 20% 17% 22% 22% Net Sales -29.2% -16.5% PER (x) 17.2 14.2 17.6 13.3 11.9 EBITDA -21.1% -4.2% P/BV 3.8 3.5 3.4 3.1 2.8 Net Profit -31.1% -13.7% EV/ EBITDA 10.8 9.4 9.8 7.5 6.5 Source: Company, RSec Research We have made changes to our Recommendation and Target Price. Please refer to Page no. 11 at the end of the report. 1 Our Thesis

Drop In LNG prices - The drop in the global oil price is structurally positive for Petronet LNG (PLNG), as all its long- term LNG contracts are oil-linked. So, a lower oil price scenario brings down its energy cost as well as reduces the Key Sectoral Theme premium of long-term contracts over the spot prices. No Risk from New Player -Mundra LNG terminal, which started operations in 3QFY20, is charging re-gas tariff of Rs63/mmbtu compared to Rs52.4/mmbtu charged by Dahej terminal. So, any new player cannot offer any long- term contract at cheaper tariff than PLNG’s Dahej terminal.

Kochi Mangalore Pipeline – The Key Growth Driver - Kochi-Mangalore pipeline is expected to be commissioned by July’20, following which the utilisation of Kochi terminal will increase to 22% in FY21E (with 28% YoY growth in volume). Improved utilisation in Kochi will aid 5% CAGR in earnings through FY20-FY223E. LNG Dispensing Stations – A New Long-term Growth Story -PLNG is planning to set up LNG stations in phases. In Phase-I, it is setting up 50 stations on 5 major highways (western and southern corridor) in FY21E. In Phase-II, it plans to set up around 300 LNG dispensing stations on the highways. Annual running cost of LNG-fuelled truck Key Investment is estimated to be 38% cheaper than diesel-operated trucks with payback period of <2 years. Themes High Dividend Payout Track Record - The company has earmarked Rs3.48bn capex for FY21. It seems the plan for addition of tanks/jetty at Dahej is being held back, which would result in significant free cash flow (FCF). The company paid 69% total dividend in FY20. With the abolition of dividend distribution tax, we estimate dividend payout at 68- 84% over FY21-22E, as we expect the Board to keep payout high, given the limited investment opportunities. However, we still expect net cash balances to go up from Rs10.2bn as at Mar20 to Rs50.2bn by FY23E.

Valuation: We downwardly revise our EBITDA estimate by 21%/4% and PAT estimate by 31%/14% for FY21E and FY22E to factor the impact of COVID-19 in FY21 and a conservative scenario for FY22. We believe PLNG offers an attractive combination of strong earnings visibility over the next 2 to 3 years, attractive valuation at 15.6x of FY23E EPS and strong cash rich balance sheet. Valuing on DCF methodology with WACC of 10% and terminal growth rate of 0%, we maintain BUY on PLNG with a 2-Year Target Price of Rs335.

2 EPS & Target Price

25.0 400 335 301 350 20.0 281 21.5 300 219 232 227 19.3 15.0 18.0 250 179 14.1 14.9 14.6 200 10.0 11.5 150 100 5.0 50 - - FY17 (-3) FY18 (-2) FY19 (-1) FY20 (Base FY21E (Year FY22E FY23E Year) 1) (Year 2) (Year 3)

EPS (Rs) Target Price (Rs)

Source: Company, RSec Research

Price Sensitivity Analysis EPS (Rs) Growth (%) FWD P/E 10.0 15.6 17.6 19.6 21.6 FY17 (-3) 11.5 23.1 115 179 202 225 248 FY18 (-2) 14.1 22.5 18.8 141 219 247 275 304 FY19 (-1) 14.9 5.7 17.8 149 232 261 291 321 FY20 (Base Year) 18.0 21.2 14.7 180 281 317 353 389 FY21E (Year 1) 14.6 -19.3 18.2 146 227 256 285 314 FY22E (Year 2) 19.3 32.7 13.7 193 301 339 378 417 FY23E (Year 3) 21.5 11.3 12.3 215 335 378 421 464 Soure: RSec Research

DCF Valuation, terminal growth rate 0% FY21 FY22 FY23 FY24 FY25 FY26 NOPAT INR mn 21,751 28,687 31,570 26,047 27,359 28,085 DDA INR mn 8,029 8,412 8,796 9,180 9,564 9,948 Capex INR mn -3,480 -5,000 -5,000 -5,000 -5,000 -5,000 FCF INR mn 26,300 32,100 35,366 30,227 31,924 33,033 WACC (%) 10% 10% Target Price 316 335 Source: Company, RSec Research

3 4QFY20 Result Conference Call - Key Takeaways

1. Negotiation with Qatar Gas for LNG: Management refrained from any comment as the deal is in progress. 2. Force Majeure: PLNG invoked force majeure for around 8 contracts of Ras-gas and 1 contract of Exxon mobile. 3. Kochi LNG Terminal: The Board of Directors has approved reduction in Kochi re-gasification charges from Rs104/mmbtu to Rs79.14/mmbtu. However, the off-takers have raised objection to reduce the charges further. A committee of directors is formed to look into the issue. The management clarified that the prices shall be reduced only if there is no impairment of Kochi assets. 4. Kochi-Mangalore Pipeline: The pipeline, which is expected to be commissioned in July’20, would increase capacity utilization by 30-35%. 5. Carrying Cost of Kochi Terminal: Carrying cost of Kochi terminal is ~Rs33bn. The management expects to recover the entire amount discounting the future cash flows at 16%. 6. Volume takeoff-take: Currently, the Dahej terminal is operating at 100% capacity utilization level. 7. Capex: The management has guided for Rs3.48bn capex for FY21 including Rs1.26bn for small-scale LNG terminal. 8. LNG Dispensing Stations: Now, the Petroleum and Natural Gas Regulatory Board (PNGRB) allows anyone to open LNG dispensing station even if not authorized for that particular geographical area, which will open new opportunities for PLNG. Earlier, PLNG used to tie-up with city gas distribution (CGD) players and the oil marketing companies (OMCs) to set up dispensing station. In Phase-I, PLNG will set up 50 dispensing stations on 5 major highways, which includes western corridor and southern corridor by FY21. In Phase-II, it will set up 300 stations on all major highways and ~1,000 in Phase-III. The management categorically stated that the company is interested more in B2B business rather than B2C business. 9. MoU with Gujarat Gas: PLNG has signed a Memorandum of Understanding (MoU) with Gujarat Gas, to set up 5 stations in Gujarat on Delhi-Mumbai Highway. 10. Other Expenses: Pre-tax profit by declined by Rs2.38bn in Q4FY20 mainly due to accounting for lease liability of Rs60 crore and impact of Rs1.78bn post restatement of liabilities on account of forex fluctuations. Other expenses for Q4FY20 stood at Rs4.04bnm which included one-time contribution to PM Care Fund (Rs1bn), forex fluctuations (Rs1.78bn), and inventory adjustments/other miscellaneous expenses (Rs310mn). 11. Finance Cost: Finance cost significantly increased to Rs1.03bn in Q4FY20 on account of AS- 116 adjustment of Rs600mn.

Key Risks f Delay in commissioning of Kochi-Mangalore pipeline. f Lower-than-expected dividend payout. f Higher spot LNG/crude prices to impact the India’s LNG consumption.

4 Investment Rationale

Our investment thesis is based on the following premises:  Decline in Spot LNG & Crude Oil Prices – Positive for PLNG  Kochi-Mangalore Pipeline – The Key Growth Driver  No Risks from New Players  LNG Dispensing Stations – A New Long-term Growth Story  Annual Running Cost of LNG-fuelled Truck is 38% Cheaper to Diesel  High Dividend Payout Track Record

I. Decline in Spot LNG & Crude Oil Prices Positive for PLNG Before COVID-19, the spot LNG price was delinked from the crude oil due to global LNG glut, while now in COVID-19 era, fall in oil prices resulted in decline of crude-linked LNG prices. India’s imported LNG volume recovered to 100% of normal level in May’20 and likely to post growth in upcoming month based on higher gas consumption by fertilizer and power plants. The drop in the global oil price is structurally positive for PLNG, as all its long-term LNG contracts are oil-linked. Thus, a lower oil price reduces its energy cost as well as the premium of its long-term contracts over the spot prices. II. Kochi Mangalore Pipeline – The Key Growth Driver Kochi-Mangalore pipeline is expected to be commissioned by Jul’20, following which the utilisation of Kochi terminal will increase to 22% in FY21E (with 28% YoY growth in volume) from 17% in FY20. Improved utilisation in Kochi will aid ~5% CAGR in earnings through FY20- FY23E. In FY23, Every 10% rise in Kochi utilisation or volume growth of 25TBTU will drive EPS by 5%. PLNG signed a one-year deal to sell LNG to Fertilisers and Chemicals Travancore (FACT) in FY20. Given the recent sharp drop in global LNG prices, we now expect this volume (around 11tbtus) to be sustained over FY21-22E as well. III. No Risks from New Players Despite being operational in 3QFY20, Mundra LNG terminal’s utilization – which was 29% in FY20 – continues to be low. We believe the new players do not pose any risk to PLNG, based on re-gasification tariffs. Currently, PLNG’s Dahej terminal charges Rs52.4/mmbtu for re-gasification vs. Rs63/mmbtu by Mundra LNG terminal. Thus, the new players are not in position to offer any long-term contract at cheaper tariff than that of PLNG’s Dahej terminal, as its re-gasification tariff is cost-effective. IV. LNG Dispensing Stations - a New Long-term Growth Story PLNG is planning to set up LNG stations in phases. In Phase-I, it is setting up 50 stations on 5 major highways (western and southern corridor) in FY21E. In Phase-II, it plans to set up around 300 LNG dispensing stations on the highways. Post this, the company plans to set up 1,000 more LNG stations. However, the company does not intend to enter into LNG fuel retailing business. In most cases, it shall set up stations in tie-ups with either the CGD players/OMCs or some other players. The basic intention of setting up LNG stations is to ensure higher LNG consumption by the automotive sector, especially the long-haul trucks and the long-haul inter-state buses. Currently, PLNG has signed a memorandum of understanding with Gujarat Gas to set up 5 LNG dispensing stations in Gujarat Delhi- Mumbai Highway, while 3 stations are being put up in tie-up with Indraprastha Gas (IGL). So Delhi-Mumbai Highway shall be covered by almost 8 LNG stations in next few months. V. Annual Running Cost of LNG-fuelled Truck is 38% Cheaper than Diesel- driven Trucks The cost of conversion of trucks from diesel to LNG is Rs9lakh. With crude prices at US$50/ bbl and exchange rate of Rs75, we estimate an LNG-fueled truck would save ~Rs7lakh (38%) annually vs. diesel truck. Thus, the payback period on investment (for conversion to LNG) would be <2 years (please refer Exhibit: 11). VI. High Dividend Payout Track Record The company has earmarked Rs3.48bn capex for FY21. It seems the plan for addition of tanks/jetty at Dahej is being held back, which would result in significant free cash flow (FCF). The company paid 69% total dividend in FY20. With the abolition of dividend distribution tax, we estimate dividend payout at 68-84% over FY21-22E, as we expect the Board to keep payout high, given the limited investment opportunities. However, we still expect net cash balances to go up from Rs10.2bn as at Mar20 to Rs50.2bn by FY23E.

5 Outlook & Valuation We downwardly revise our EBITDA estimate by 21%/4% and PAT estimate by 31%/14% for FY21E and FY22E to factor the impact of COVID-19 in FY21 and a conservative scenario for FY22. We believe PLNG offers an attractive combination of strong earnings visibility over the next 2 to 3 years, attractive valuation at 15.6x of FY23E EPS and strong cash rich balance sheet. Valuing on DCF methodology with WACC of 10% and terminal growth rate of 0%, we maintain BUY on PLNG with a 2-Year Target Price of Rs335.

Exhibit 1: PLNG 1 Year Forward P/E Valuation Exhibit 2: PLNG 1 Year Forward Ev/EBITDA Valuation

21 14

19 13 12 17 11 15 10

13 9 8 11 7 9 6 7 5 11 11 11 11 15 18 16 15 18 14 12 19 12 18 19 16 16 14 12 19 14 12 18 19 15 16 17 14 10 13 15 17 10 13 - - - - 20 20 ------Jul Jul Jul Jul Feb Feb Sep Oct Sep Jun - Oct Jan Jun - Jan Apr Feb Apr Apr Feb Apr Sep Dec Sep Nov Jun - Nov Dec Nov Nov Jun - Mar Aug Mar Aug May May

BEST_PE_12M_BF Average STDEV+1 STDEV-1 BEST_EV/EBITDA_12M_BF Average STDEV+1 STDEV-1