Fund Call. Why you should buy Petronet LNG despite the rally

Since our last buy call in April 2019, the stock of gas importer and regasifier Petronet LNG has gained about 16 per cent. This was aided by the completion of capacity expansion at the Dahej terminal that helped the company deliver volume growth in the June and September 2019 quarters, after a lacklustre show in the prior few quarters.

Despite the rally, the Petronet stock remains a good buying opportunity for investors with a long-term perspective. One, its valuation is reasonable. At ₹263, the stock trades at 17 times its trailing 12-month earnings, lower than its average valuation of 18 times in the past three years.

Also, there is scope for further increase in the company’s volumes and profits in both near and long term. This is thanks to low international gas prices currently that aid spot volumes, progress in the laying of pipelines that should improve capacity utilisation at the Kochi terminal and additional capacity expansion planned at the Dahej terminal in the coming years.

Gas imports into India are set to increase with rising demand and low domestic production, and Petronet as the market leader should benefit from this.

Capacity expansion

In late June 2019, the capacity expansion of Petronet’s Dahej terminal from 15 mtpa to 17.5 mtpa was completed. This, along with more spot contracts, gave a boost to the company’s volumes that increased about 3 per cent y-o-y in the June 2019 quarter and about 15 per cent y-o-y in the September 2019 quarter. Operating profit (EBITDA) grew about 9 per cent in the June quarter and about 19 per cent in the September quarter, compared with the year-ago periods. But in the June quarter, this was offset by higher interest and depreciation costs, and accounting adjustments pertaining to leases, resulting in about 5 per cent y-o-y decline in net profit to ₹560 crore. In the September quarter though, despite higher interest and depreciation costs, net profit nearly doubled to ₹1,103 crore thanks to adoption of lower corporate tax rates and consequent reversal of deferred tax liability.

The Dahej terminal has been consistently operating at more than 100 per cent its nameplate capacity, and volume growth benefits from the expansion will continue for a few more quarters. Besides, the expected commissioning of the Kochi-Mangaluru pipeline in the coming months should further aid the 5 mtpa Kochi terminal’s capacity utilisation that is now around 15 per cent from single digits earlier. The low gas price environment that is expected to continue due to the global supply glut should aid Petronet’s spot gas volumes. Also, the 5 per cent annual price escalation in regasification tariffs for its long-term supply contracts at the Dahej terminal should help the company’s financials; the price escalation happens in January.

Over the coming years, a further expansion of the pipeline network should translate into additional utilisation of the Kochi terminal. Also, Petronet is working on two more tanks and a third jetty in Dahej that should lead to better utilisation of the terminal. The company plans to increase the capacity of the Dahej terminal to 20 mtpa by 2024. Demand and capacity utilisation could further improve if plans for LNG as transport fuel take off in a big way; pilot projects are underway.

Well-positioned

Gas demand in the country is expected to grow at a healthy pace.

The Centre wants to increase the share of the fuel in the country’s energy mix from the current 6 per cent to 15 per cent and is taking many steps towards this, including aggressive expansion of the city gas distribution network across the country. It helps that the price-competitiveness of natural gas over several alternative fuels has increased with the decline in global liquefied natural gas (LNG) prices.

Import dependency that is now above 50 per cent is likely to increase due to weak domestic supplies; this should benefit players such as Petronet.

While new LNG terminals are being set up in the country by other players, too, Petronet, a first-mover in the sector, should be able to retain its leadership position. The Dahej terminal has been set up at a relatively lower cost and offers Petronet a competitive advantage.

A strong balance sheet with comfortable leverage and strong cash level position the company well to fund its expansion plans.

Petronet’s deal last year with US-based LNG company Tellurian to acquire stake and buy gas cargoes had raised concerns about sub-optimum capital allocation.

But the concerns may be overdone given that the deal is in the nature of a non-binding memorandum of understanding; the buyers’ market in the LNG sector puts Petronet in a position of strength in negotiations.

The company is a regular dividend payer, with the current dividend yield more than 3.5 per cent.

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