GSPL

Gujarat State Petronet Ltd (GSPL), engaged in natural gas transmission, presents a good buying proposition for investors with a medium-term perspective. At the current price of Rs 87, the stock discounts the trailing 12-month earnings by around 14 times.

This compares with around 18 times for GAIL and 19 times for Gujarat Gas — companies engaged in both gas transmission and marketing. Despite almost doubling from February 2009 lows, good financial metrics, expected volume growth from favourable industry dynamics and GSPL's expansion plans provide scope for further upside.

GSPL, a group company of Gujarat State Petroleum Corporation (a Gujarat-government controlled hydrocarbon explorer and producer), is a promising play on the high-potential natural gas sector in India.

GSPL enters into gas transmission agreements and connects gas supply sources with consumption centres through pipelines, the construction of which is outsourced to third-party contractors. The company's take-or-pay model with customers helps cushion revenue. Also, being solely engaged in gas transmission insulates GSPL from gas pricing vagaries and makes it primarily a volume-driven play.

GSPL, which transports gas on open access basis (allowing users or producers to access its pipelines for a transportation fee) has an extensive transmission network (1,420 km) in Gujarat, India's most developed gas market. It plans further expansion (around 800 km, of which 450 km is under execution) to cover all districts in the State. The company is also looking at expanding outside the State, and has submitted letters of intent for four intra-country pipelines totalling 5,675 km.

In addition, it has acquired exposure to city gas distribution through investments in Sabarmati Gas and GSPC Gas Company Ltd in Gujarat, and Krishna Godavari Gas Network Ltd in Andhra Pradesh. GSPL is also said to be in talks to acquire a stake in the proposed Mundra LNG terminal promoted by the GSPC-Adani consortium. Besides, it has received shareholder approval to enter the power generation business.

Strong volume growth

GSPL has grown strongly over the years (24.4 per cent annual growth in net sales from 2005 to 2009 to Rs 487.5 crore, and 66.5 per cent annual growth in net profits to Rs 123.4 crore ), primarily driven by increased gas transmission volumes.

Though 2009 sales and profit growth (16.7 per cent and 23.5 per cent, respectively) were lower than average primarily due to user substitution of spot natural gas by cheaper naphtha for some part of the year, growth has recouped strongly in the current fiscal.

The first nine months of this fiscal saw sales more than double, and profits more than treble over the previous year. This was primarily due to a sharp uptick in volumes transported which grew 96 per cent over the previous year to 8,395 million metric standard cubic meters.

Strong volume spurt was primarily driven by Reliance commencing gas supplies from its KG-D6 well in April 2009, and ramping up production during the year. Also, an increase in LNG imports aided volume growth.

During the current fiscal, GSPL enjoyed EBITDA margins of around 96 per cent (up from around 93 per cent last year) and strong net margins of above 40 per cent (up from around 25 per cent ), aided by sharp volume growth, no connectivity charges and significantly lesser gas transportation charges. Sharp divergence in EBITDA and net margins is primarily on account of high depreciation, given that the company continues to be in capital investment mode. This, however, bodes well for future growth.

Positive outlook

High demand and increasing supply of natural gas is expected to benefit GSPL. From around 36 million metric standard cubic meters per day (mmscmd) currently transported by GSPL, volumes are expected to further increase, with additional supplies likely to flow from the Reliance KG basin and planned LNG capacity increases.

Volumes would receive further boost once the ONGC and Gujarat State Petroleum Corporation gas fields in the KG basin also go on stream. Also, stake in the proposed Mundra LNG project could provide gas supply security to GSPL.

In the near future, full execution of GSPL's contracts to supply gas to RIL's refinery and Torrent Power is expected to increase volumes. Even if volumes do not grow at the scorching pace seen in 2010 (due to high base effect and RIL's KG-D6 well achieving peak production), growth is still expected to be healthy.

Risks

The 30 per cent pre-tax profit contribution towards charity proposed by the Gujarat government for state-controlled entities, if implemented, will impact profitability.

Proposed caps on return on capital, may see average transmission realisation decline.

Also, the company's proposed foray into non-core businesses such as power generation might dilute focus and impact margins.