Petronet has re-rated in the past two years to near all-time highs as contract risks abated and earnings visibility improved. Even after an 87% y-o-y rise in FY17, e.g., we expect EPS to rise at a steady 13% CAGR in FY17-21e along with rising ROCE/FCF. With 10% growth likely even beyond as volumes/tariffs rise, its 10% PE discount to the market (where EPS momentum has slipped) renders risk/reward favourable. We assume at Buy and a DCFE-based Rs 280 price target. Surplus: India’s long-term gas demand outlook has rarely ever been in question, but we expect a more moderate 6% CAGR in off take in FY17-21e even as domestic gas output has started to inch up after falling for five years. With import capacity of more expensive LNG set to double, utilisation rates at terminals may drop to 54% in FY21e vs 75% in FY17.
De-risked: Petronet is well positioned to thrive amid this uncertain outlook. Its existing capacity at Dahej has been pre-sold on long-term contracts with its 2.5mt expansion (due FY19) also likely to find takers given its industry low re-gas tariffs. The outlook at Kochi is improving too, with Gail targeting FY19 to complete the Kochi-Mangalore pipeline.
Visibility: Much of the improved outlook is already reflected in the share price that is up 166% in the past two years (Sensex: +25 %) with institutional ownership and valuations near historical peaks. Yet, even after EPS rose 87% in FY17, we expect a 13% CAGR in FY17-21E with double-digit growth even beyond, helped by higher volumes and re-gas tariffs.
Tariffs: Indeed, the contractual 5% y-o-y tariff rise is a strong tailwind that underpins long-term cash flow growth even as cost of capital is falling (lower yields and beta). Uncertainties have emerged on tariffs before (2005, 08, 12), due to demand-supply and regulatory scrutiny, and may rear up again but may not be a near-term overhang.
Spend: A more intangible uncertainty is capital allocation; it is nearly net cash with a surge in FCF still ahead. Dividends may rise, therefore, but Petronet is searching for growth too. We draw comfort from its track record at Dahej and its intent to not repeat its Kochi mistakes by de-risking cashflow before committing capex.
Buy: Its de-risked steady growth profile even as valuations are a 10% discount to the market renders reward favourable. We
assume with a Buy rating.
Our Rs 280 price target is based on a DCFE at 11.5% COE. Risks: softer LNG demand, cut in re-gas tariffs and large risky new projects.Investment thesis. We assume coverage on Petronet LNG with a Buy, expecting earnings to rise at 13% CAGR in FY17-21e helped by rising volumes at both Dahej and Kochi. With capital spend on these terminals also likely to ease and re-gas tariffs rising 5% each year; we expect cash flow to surge too with FCFE yields at about
7% by FY21e. This brings attendant risks of investing in poorly conceived new projects too, but we are comforted by Petronet’s past track record, prudence on capital allocation and intent to target a 30-40% payout. Our DCFE-based Rs 280 PT suggests 20% potential upside. Key risks include soft LNG demand, a cut or regulation of re-gas tariffs and large investment without adequate ring-fencing.
Demand outlook is promising but gradual rise near-term
With natural gas making up 6.2% of overall primary energy demand in India, the long term outlook for gas demand has rarely been in question. Yet, the immediate trajectory has almost always lagged with a combination of supply availability, economic activity, connectivity or price of competing fuels weighing on offtake. Jefferies analyst Arya Sen projected a 6% CAGR in gas demand in FY17-20e therefore, in his 16 May ’17 Franchise Report, leaving them well below latent demand forecasts that are 2.5-3.5x as much.
Domestic gas production has also inched up in recent months
In addition, domestic gas production is also beginning to inch up after five years of declines as ONGC’s long delayed projects trudge towards completion; output has risen 5.7% in the last year, for example. The government promises an even more aggressive ramp-up in the years ahead as ONGC and Reliance invest in their East Coast discoveries but this is still some time away. Nonetheless, output could still rise at a 3% CAGR in the next five years helping meet some of the incremental demand that we forecast.