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Strong fundamentals & attractive valuations make Gujarat State Petronet Limited an attractive buy

key challenge in the oil and gas business is to develop the infrastructure required for transmitting oil and gas. For Gujarat State Petroleum Corporation Ltd (GSPC), which is into the discovery and extraction of natural gas, Gujarat State Petronet Limited (GSPL) was a logical forward integration strategy. GSPL develops the pipeline infrastructure that transmits gas across Gujarat and ultimately allows last-mile linkage with the end-user.
Starting from a 15-km line in 2001, the company has over the past decade increased its pipeline network to 1,874 km, spanning 18 of the 26 districts of Gujarat. Today the company transports over 35 million metric standard cubic metres per day (mmscmd) of natural gas on behalf of more than 31 customers, which include refineries, steel plants, fertiliser plants, power plants and other industries within the state.
GSPL’s parent GSPC holds working interest in 15 fields in the Cambay Basin and 64 onshore and offshore exploration and production blocks. Fifty-three of these blocks are located in India and 11 are located in Australia, Egypt, Indonesia and Yemen.

Strengths Investments in gas distributors. Unlike other oil and gas players such as ONGC, GAIL or IOCL for whom managing pipelines is a secondary function, GSPL is a pure-play transmission company. It holds a 13.75 per cent stake in Sabarmati Gas and 36.59 per cent stake in GSPC Gas. These are among the largest city gas distribution network providers in the country. Altogether GSPL has invested Rs 76.50 crore in these two entities. If and when these companies decide to go public, GSPL could earn huge gains on its investments.
The risk of value unlocking not happening, or not happening for a long time, does exist. Yet it is a strategy that could pay handsome dividends to long-term investors.
Open access. GSPL has reduced its dependence on GSPC, which means that even if new gas discoveries do not happen, or output from existing blocks falls, GSPL’s revenues are expected to remain stable. This is because it allows open access to its pipelines to a variety of players. The company has signed a 15-year agreement with Reliance for transporting 11 MMSCMD and another 20-year agreement with Torrent Power for transporting 4.5 MMSCMD. These long-term agreements lend visibility on capacity utilisation and revenues.
High entry barrier. The nature of this industry is such that it involves huge capital expenditure. As a result, very few companies have ventured into this business in recent times.
Moreover, once the pipeline has been laid along a particular route, it makes no economic sense for a rival pipeline company to lay another pipeline along the same route. The myriad approvals required to lay pipelines, including Right of Usage (RoU) and Right of Way (RoW), also keep competition at bay.
GSPL’s first-mover advantage and competitive advantage are reflected in its FY11 return on equity (RoE) of 28 per cent and EBIT margin of 83 per cent.
Bi-directional transmission. GSPL’s gas grid is equipped with the latest bi-directional gas transmission technology to enable two-way flow of gas. This introduces a lot of flexibility into the task of transmission by allowing gas to be sourced or uploaded at either end of the pipeline network.
Institutional support. The test of a business is the investment interest that it manages to garner from financial institutions. Over time the number of mutual funds that have invested in GSPL has increased: mutual funds accounted for 3.46 per cent of the company’s total shareholding in 2006-07, but by September 2011 this had gone up to 14.95 per cent. Some of the major funds that had allocated over 4 per cent of their portfolio to GSPL as on October 30, 2011 included Sundaram Energy Opportunities, Magnum COMMA, Franklin India Prima, and IDFC Infrastructure.

Opportunities
Transmission through pipelines will in future be the preferred mode for transporting natural gas due to its safety and efficiency. An increasing number of cities are turning to natural gas for cooking and transportation. This augurs well for gas demand in future. As the largest gas grid infrastructure provider, GSPL is bound to gain from the rise in gas demand.
Three pipeline projects adding up to about 4,000 km have been awarded to a GSPL-led consortium (GSPL-52 per cent, IOCL-26 per cent, BPCL-11 per cent and HPCL-11 per cent). These pipelines are to be commissioned by mid-2014. This will be GSPL’s first venture outside Gujarat and will be a test of its ability to perform outside the state.

Weaknesses and threats
Tariff regulation. Tariff regulation has a big say in this business. This is a matter of concern for GSPL as well. Under the Petroleum & Natural Gas Regulatory Board’s (PNGRB) framework, the companies involved in gas transmission, like GSPL and GAIL, have to calculate tariffs as per PNGRB’s directives. Any adverse policy decision by the regulator or a low cap on tariffs could affect the company’s revenues significantly.
Foray into wind energy. The company has set up 52.50 MW of wind power projects at Maliya Miyana (District-Rajkot) and Gorsar & Adodar (District-Porbandar). These projects posted a revenue of Rs 14 crore in FY11, which is less than 1.5 per cent of total revenue. However, the bottom line amounted to a loss of Rs 15 crore. Non-core business interests such as power generation could dilute the company’s focus and affect its future earnings.
Low gas output. Low gas output by associate companies and customers could reduce the quantum of gas available for transmission, thereby affecting GSPL’s revenues. Also, for the last eight quarters, gas volumes have been more or less stagnant.
Record outside Gujarat. The company’s track record outside Gujarat needs to be tested, especially when the role of the state government has been pivotal in its achievements. How well it performs in states where it does not have the implicit support of their state governments remains to be seen.

Financials
GSPL has registered a healthy five-year CAGR of 32 per cent in revenue growth and 60 per cent in earnings per share (EPS) growth. Despite the capital-intensive nature of the business, it has a debt-equity ratio of only 0.74, which allows it to explore nationwide expansion plans. The company reported operating profit margins of 83 per cent (EBITM) in FY11, which is high compared to its five-year average of 42 per cent. This steep rise is on account of a significant change in its depreciation policy. Since 2006, the company has never skipped or reduced dividend payment to shareholders.

Valuation
The stock is currently trading at a PE of 8.59, which is significantly below its five-year median P/E of 18.83. The current PE is very close to its lifetime low. Based on five-year CAGR of earnings per share (EPS), the company is available at a very attractive price-earnings to growth (PEG) ratio of 0.17.
Strong fundamentals and attractive valuations make this stock an attractive buying proposition. Investors with at least a three-year investment perspective may invest in this stock.