The Hindu Business Line : Petronet LNG: Buy

Investors can consider acquiringPetronet LNG stock with a long-term perspective. The company is in a growth phase and accounts for a quarter of the domestic gas market. The growing demand for natural gas augurs well for Petronet's expansion plans while the near-term earnings are likely to be buoyed by spot and short-term market cargoes.

The growing acceptance of regasified LNG (liquefied natural gas) by users such as power and fertiliser companies, even of gas sourced at relatively higher rates in the spot market, holds out promise for Petronet's business .

Business model

Petronet imports LNG on a long-term contract with Ras Gas of Qatar and at its regasification terminal in Dahej converts it into natural gas which is then marketed by GAIL, Indian Oil and Bharat Petroleum. Its income comes from regasification charge which escalates by 5 per cent every year as per the agreement with the buyers. In addition , Petronet has, over the last two years, been sourcing small cargoes from the spot LNG market and processing them for buyers mainly from the power and fertiliser sectors which have been affected by the sharp rise in liquid fuel prices. What augurs well

Given that the buoyancy in earnings can come only from higher regasification volumes, Petronet's strategy to develop a spot and short-term market for gas is a major plus for the earnings growth prospects. The regasification charges from additional spot and short-term volumes go straight to the bottomline as the fixed costs are fully absorbed over the installed capacity. This fiscal, Petronet will be sourcing 1.5 million tonnes of LNG from the short-term market for the Dabhol power project; this will take its total regasification volumes to 6.5 million tonnes. Petronet's plans to expand capacity at Dahej to 12.5 million tonnes by 2008-09 for which the finances have been tied up; this is a positive but much would depend on how successful it is in sourcing long-term LNG at competitive rates. What could come to its aid though is that liquid fuel alternatives that power and fertiliser producers use such as naphtha and fuel oil cost upward of $12 per MBTU which makes LNG even at $8 per MBTU an economical option.

The best part of the expansion plans is that Petronet gets the right to market the capacity over and above 7.5 million tonnes which will enable it to partake in marketing margins.

Petronet's long-term plan to set up a second LNG jetty at Dahej and two more LNG storage tanks in association with Gujarat State Petronet will give it greater flexibility; with additional investment in regasification, the overall capacity of the Dahej complex can be taken past 20 million tonnes per annum.

The downside

Pricing and quantity uncertainties linked to sourcing additional LNG under long-term contracts and the entry of domestic gas from the finds on the east coast are the two biggest challenges for Petronet. The Kochi terminal will be mechanically complete by 2010 and the company hopes to source gas from the Gorgon project of Chevron in Australia, which has been delayed and is not likely to ship out its first LNG consignment before 2012. Petronet may have to operate the Kochi terminal with spot market LNG in the interim.

This is where pricing will become crucial as domestic gas is expected to enter the market by end-2008 though neither the quantum nor its possible pricing is clear at this point in time. What is certain though is that the KG Basin gas will flow into the west coast market — which is Petronet's domain now — through a couple of cross-country pipelines.

The market for Petronet's regasified LNG from the expanded capacity at Dahej and the new terminal at Kochi will be a function of its own price, the price quoted by domestic suppliers and the qualityof their gas and the then prevailing prices of liquid fuel alternatives.

Meanwhile, the price of LNG sourced under the existing long-term contract with Ras Gas will increase come 2009 when the five-year price freeze as per the contractual terms ends. Thereafter, the price will move in a band to be agreed with a floor and a cap. However, it may not be difficult for Petronet to pass on the higher cost to buyers given the rapidly growing demand for gas and the fact that liquid fuel prices are projected to remain at levels that will make gas an economic alternative.

Petronet reported an excellent performance for 2006-07 with revenues and earnings growing by 44 per cent and 60 per cent respectively to Rs 5,545 crore and Rs 313 crore respectively. The current market price of Rs 51 discounts the trailing EPS of Rs 4.18 by 12 times. The stock can be acquired strictly with a long-term holding perspective.

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