Petronet LNG: HOLD. Petronet LNG: In the pipeline

Over the past month, the stock of gas importer and regasifier Petronet LNG has shot up about 20 per cent. This has been primarily due to reports that Qatar’s RasGas may modify its long-term LNG contract of 7.5 million tonnes per annum (tpa) with the company.

The reports, not yet confirmed by Petronet, say that RasGas has agreed to change the pricing formula from 12-month average rates to three-month average rates, and also remove the floor and cap on prices based on 60-month average.

This change would align the cost of the imported gas close to market rates, in effect bringing it down to about $7 an mmbtu from $12.5.

The reports also suggest that RasGas would not levy the ‘take-or-pay’ liability on Petronet for not picking up the entire contracted long-term volumes this year — during the nine months ended September 2015, Petronet’s offtake has been 68 per cent of the contracted volumes.

The news, if and when confirmed by the company, would be a big positive for Petronet. One, it would remove the major overhang of take-or-pay liability on the stock. The sharp fall in global LNG prices over the past year has made spot LNG prices much cheaper than Petronet’s long-term contract price with RasGas. So, Petronet’s end customers are not picking up their contracted volumes, opting instead for cheaper spot gas.

In turn, Petronet too has backed off from picking up costly supplies from RasGas. While Petronet also has take-or-pay contracts with its end-customers, implementing these could be messy and long-drawn.

Next, global gas prices are likely to remain subdued, at least in the medium term, due to tepid demand and new supply sources. There is significant demand for cheap gas in India.

So, the reported market-linked rates should help Petronet easily find buyers for its wares from its existing and upcoming capacities. No surprise then that the market gave the news a thumbs-up.

At this juncture though, investors can hold on to their stock but avoid fresh exposure. For one, after the run-up, the valuation is not cheap.

At ₹242, the stock trades at about 19 times its trailing 12-month earnings, higher than the average 14 times it traded at in the past three years.

Importantly, business uncertainties remain. Petronet’s five-mtpa Kochi terminal is still mostly idle due to lack of pipeline connectivity to Bangalore and Mangalore to be provided by GAIL; this is the fallout of land acquisition disputes with farmers in Tamil Nadu and Kerala.

While there are some positive indications about the Kerala government’s steps to get the Kochi-Mangalore pipeline expedited, the process is likely to be long-drawn.

Meanwhile, Petronet continues to incur high depreciation and interest costs — the company’s loss in 2014-15 due to under-utilisation of the Kochi terminal is estimated to be about ₹500 crore. In 2014-15, Petronet’s profit (₹889 crore) was 24 per cent higher year-on-year. But this was thanks in part to a low base in 2013-14 when profit dipped 38 per cent.

In the recent September quarter, despite improvement in volumes, profit fell more than 5 per cent.

The mainstay 10 mtpa Dahej terminal is being expanded to 15 mtpa. But this could take at least another year.

Meanwhile, the scope for volume expansion remains limited, even if LNG cost falls. That’s because the Dahej terminal is already operating above 100 per cent capacity utilisation.

The final contours of the Petronet-RasGas renegotiated contract also remain to be seen; any unpleasant surprises can prove a drag. But with hope around, it seems apt to wait out now.

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