Domestic gas should contribute to less than 50% of India?s gas demand of 400 mmscmd (million standard cubic metre per day ) by FY20e, leaving ample room for imports of liquefied natural gas. LNG import terminals are running at 95% utilisation and several new ones have been announced. But because LNG prices are high, demand may be restricted to retail consumers switching from liquid fuels.
We believe growth in demand from retail consumers will not be enough to absorb all the capacity from new LNG import projects. Therefore, the projects first out off the blocks stand to benefit the most. Petronet LNG (PLNG), which is doubling its import capacity starting FY13e, is ahead of the curve. Without the ability to source sub-$10/mmbtu LNG, we expect demand growth will come mostly from retail consumers rather than industrials, refineries and compressed natural gas producers. Hence, we see PLNG?s utilisation dipping from 100% to 78% by FY14.
As a supplier of compressed natural gas for vehicles and piped gas to industrial consumers in Delhi and surrounding areas, Indraprastha Gas Limited (IGL) can maintain a gross margin of about $5/mmbtu. This, in turn, will allow profit to grow in line with volume despite subsidized diesel prices and potential government intervention.
Neutral rating.
We value PLNG at 15x and IGL at 17.5x FY13e EPS. Our FY12e and FY13e EPS estimates for both are in line with consensus. Both stocks have outperformed the Sensex by about 50% over past one year on better earnings visibility but look fairly valued.
India imports all forms of energy, including natural gas. Imports contribute 28% to total natural gas supply in the country. Falling domestic production has further fuelled imports. Additionally, we do not expect any material addition to domestic gas production over the next four to five years. This clearly is helping natural gas importers, like Petronet LNG, which is doubling the capacity over the next four to five years. However, due to rising LNG prices (doubled in the past year), we believe anchor customers, like the power sector, would shun imported gas. Our analysis shows that consumers looking for a substitute for liquid fuels are the only likely consumers of costly LNG, thereby limiting growth of LNG in India. However, due to a sudden dip in domestic gas supply, many industrial houses are keen to set up import terminals. Petronet LNG was the fastest company off the block; it has the first-mover advantage. We believe the current valuation of PLNG already factors in reasonably high utilisation of its expanded capacity. However, we do not anticipate any near term negative trigger for the stock either; hence we are initiating with a Neutral rating.
The tie-up of long-term LNG would be a significant trigger, while continuing spot cargo would add to earnings in the form of both regas charges and marketing margins.
Indraprastha Gas Limited (IGL), which supplies gas to the National Capital Region (NCR) of Delhi and has a monopoly over a large part of its coverage geography, would continue to benefit from growth in compressed natural gas (CNG) for vehicles, as CNG remains cheaper than even subsidised diesel. However, we believe IGL is also fully valued and hence are initiating on the stock with a Neutral rating. Like PLNG, the downside risk for IGL is also limited. IGL?s supply exclusivity runs out in 2012, but we do not see intrusion into IGL?s area due to the shortage of gas and the moderate marketing margin being charged by IGL. Our calculation indicates that the effective tariffs being charged by IGL are within the regulatory norm (14% post-tax return on capital employed).
Like PLNG, we believe IGL is also fairly valued. But with no foreseeable negative triggers either near term. Both these stocks have moved together and outperformed the index due to higher earning visibility and less attractive investment options in the Indian energy domain.
We expect domestic production to lag demand growth. The gas market in India is supply driven, with both domestic gas supplies and imported gas supplies in the form of LNG needed to meet demand. In addition, domestic supply is falling and new domestic fields have yet to begin producing. A large number of fields being operated by government-owned upstream companies are old and in decline. They require substantial capex just to maintain production. Marginal fields are now being monetised, but we believe new production would be just enough to offset the decline from older blocks. Therefore, our estimates assume largely flat production from government-owned upstream companies.
Even large new blocks operated by private companies, like KG-D6, have disappointed, with production declining by 25% within two years of coming on line. Other newly discovered fields are unlikely to change the demand supply dynamics. Furthermore, domestic production is supplied according to government allocation policy, with fertiliser plants first in line to receive supplies, followed by LPG extraction companies and power plants. There is enough unmet demand from these sectors to use up any incremental domestic gas, leaving little for other sectors.
India has two LNG terminals with a total capacity of 13.5 mt or 50 million standard cubic feet per day (mmscfpd). In expectation of strong demand, several new LNG terminals have been proposed to quadruple the existing import capacity. However, mere availability of capacity is not enough to meet demand. Imported LNG is priced at a significant premium to domestic gas and its use makes some of the price sensitive projects unviable.
We have analysed the status of each of the planned projects and believe that Petronet LNG?s expansion at an existing location at Dahej and a greenfield plant at Kochi in south India would be the first ones to be commissioned over FY13-15. Consumers are the only buyers of costly LNG. The price of LNG in Asia has consistently risen during the past one year and we believe prices will continue to trend higher as imports to Japan are likely to rise following the closure of the country?s nuclear plants at Fukushima.
In India, the power sector continues to shun imported LNG, while fertilizer companies can only afford LNG due to government subsidies. We anticipate refineries and small commercial enterprises would be the main driver of growth in imported LNG over next 5-6 years. But even then, the current high price of LNG means refineries are neutral on using LNG versus fuel oil. Further increases in LNG price would lead to the loss of refineries as a consuming class. Refineries consume more than 50% of spot LNG and has the potential to use up 70% of the current import capacity over next two to three years.
A comparison of LNG prices with other fuels indicates that only liquid fuel consumers can find a reason to switch to LNG at the current spot price level. City gas distribution (CGD) customers are essentially substituting CNG for diesel or petrol, and piped natural gas (PNG) for LPG. We compare natural gas prices in cities with liquid fuels. CNG used by vehicles is 65% cheaper than petrol, 35% cheaper than diesel and 37% cheaper than LPG. Aside from the cost advantage, CNG also offers environmental benefits.
Similarly, at current prices, PNG used for cooking is at least 12% cheaper than the current subsidised price of LPG cylinders and 50% cheaper than the unsubsidised price of LPG cylinders. We anticipate continuing 100% utilisation of PLNG?s existing terminal and believe its expansion at the existing site will also have high utilisation due to its location in the largest consuming region in India and access to major oil refineries. However, our customer-by-customer analysis of south India indicates its new terminal down south in Kochi will see a slow ramp-up.
IGL, on the other hand, benefits from continuing growth of both the CNG and PNG segments. We anticipate 14.6% and 9.3% growth for CNG over FY12 and FY13, respectively, and 50% and 40% growth for PNG segment in the same period, respectively, based on historical growth trends and the impact of the recently inaugurated metro networks in Delhi NCR. Both companies have outperformed the Sensex index by about 50% over past one year on better earnings visibility and the uncertainty surrounding the earnings outlook for other energy companies.
Valuation and forecasts
Indraprastha Gas IGL?s earnings have been growing at a CAGR (compound annual growth rate) of 14% over FY08-11, generating an average ROE (return on equity) of around 28%. In the past one year, the stock has outperformed the Sensex index by 48%. We expect IGL to achieve a CAGR in earnings of 13.1% over FY11-14. This estimate is based on 16% volume growth and the assumption that the company can pass on a large part of the increased cost of gas to customers.
We value IGL at 17.5x FY13e EPS of R27.1, resulting in a target price of R475. The PE multiple is in line with the forward PE for the past 12 months and reflects a 13.5% WACC (weighted average cost of capital), 10% growth rate and 26% ROE. Our target price indicates a 12% potential return, including dividend yield. Hence, we rate the stock Neutral. The key risks are volumes coming in higher or lower than expected, the company being unable to pass on increases in gas costs to consumers, and the entry of new players.
Petronet LNG
Petronet LNG?s earnings have grown at a CAGR of 9% over FY08-11, generating an average ROE of 25% for the period. During the past one year, the company has outperformed the Sensex index by 73%. We expect Petronet LNG to achieve a CAGR of 20% on earnings over FY11-14e. Our estimates are based on the assumption of 100% capacity utilisation at the Dahej terminal and gradually increasing utilisation at the Kochi terminal, which we expect to be commissioned by end-FY13.
We value PLNG at 15x FY13e EPS of R12.2 for a target price of R185. This multiple is in line with the average for the last 12 months. Our target price implies a 12% return including dividend yield. Hence, we rate the stock Neutral. The key risks are lower-than-expected regas volumes, a downward revision in regas tariffs, and higher-than-expected marketing margin.
?HSBC