Petronet LNG: Sell

Similar to many of its peers in the oil and gas space, the stock of gas importer and regasifier Petronet LNG has been on a tear this year. The stock has gained 90 per cent since January end. But unlike the public sector oil companies whose business prospects have brightened, thanks to pricing reforms, Petronet has little to show in terms of improvement in fundamentals. On the contrary, the company’s performance has been continuously slipping.

For five quarters now, its profit has been lower than in the year-ago period. Petronet’s annual profit in 2013-14 — ₹712 crore — was 38 per cent lower than that in 2012-13 — the first such decline, and in the recent June quarter, profit dipped 31 per cent.

The deterioration in the company’s performance is primarily due to severe underutilisation of its five-mtpa Kochi terminal in the recent June quarter — capacity utilisation at the terminal was just 1 per cent.

The Kochi terminal built at a cost of about ₹4,500 crore and commissioned in August last year has borne the brunt of the significant delay in the construction of pipelines by GAIL (India) to transport the regasified gas to potential customers. The Kochi-Bangalore pipeline has come unstuck due to protests by farmers in Tamil Nadu who object to the pipeline passing through their lands.

The matter is pending in the Supreme Court and there is significant uncertainty on whether the pipeline construction will recommence.

Progress on the Kochi-Mangalore pipeline too, which passes mostly through Kerala, has been far behind schedule mainly due to matters pertaining to land acquisition.

The issues in both Tamil Nadu and Kerala are unlikely to be resolved soon, especially with state elections due in 2016. It doesn’t help that even some of the few existing customers such as the Kerala Government-controlled fertiliser company FACT have stopped buying regasified LNG from the Kochi terminal, citing uneconomical prices.

Ergo, capacity utilisation at the terminal could be restricted to low single-digits in the near- to mid-term.

Meanwhile, even as revenues are stranded, the company will continue bearing the depreciation and interest costs associated with the terminal. Petronet’s management has indicated that the loss on account of the Kochi plant in 2014-15 could be about ₹500 crore. Petronet’s mainstay 10-mtpa terminal at Dahej in Gujarat has been operating at 100-110 per cent capacity utilisation for some years now.

So, despite there being potential (provided the price is right) for imported regasified gas to substitute declining domestic natural gas supply, Petronet may not be able to capitalise on the demand in the near- to medium term given its capacity constraint.

The next phase of significant revenue growth at the Dahej terminal could happen after completion of the planned 15 mtpa expansion — this may take another two to three years.

To sum, Petronet’s financials are likely to remain under pressure for the next few years due to the travails at the Kochi terminal. Last August, we had given a ‘buy’ call on the Petronet stock at ₹124 on expectations that the gas pipeline imbroglio would be sorted out quickly in the interest of all stakeholders.

The dispute now seems to be set for the long haul through the legal route. Meanwhile, the stock has rallied sharply seemingly in a sympathetic upmove along with other oil and gas scrips.

Investors can use the opportunity to book profits. At ₹198, the stock discounts its trailing 12-month earnings by about 23 times. This is much higher than the average of 13 times it has traded at in the past five years.

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