Gujarat State Petronet Limited (GSPL) is India’s only pure natural gas transmission company, operating the second largest natural gas transmission network after GAIL and enjoys a market share of 16% compared to GAIL’s 78%.
We believe that GSPL is a long-term play on rising natural gas supplies with FY11 being the inflexion year when GSPL’s delayed agreement with Reliance Industries (RIL) to transport 11mmscmd of gas kicks in.
We expect GSPL’s gas volumes to increase at 26.8% between FY08 and FY11 driven by its contracts with RIL and Torrent Power.
Petroleum and Natural Gas Regulatory Board’s (PNGRB) new tariff regulations prescribe a pre-tax ROCE of 18.2% for gas transmission utilities. GSPL’s existing tariffs calculated as per the new regulations imply ROCE of 15.2% in FY08.
Also, during the first five years, the volumes used for computing tariffs are lower than actual volumes leading to higher tariffs.
Factoring in the impact of these regulations into our estimates, we expect adjusted pre-tax ROCE to improve to 21.6% in FY11.
Reported ROCE will however remain depressed until FY11 due to high CWIP as well as contribution of 30% of PBT toward social development purposes in Gujarat.
We use EV/EBITDA multiple to value GSPL on FY11 basis and discount the target price by our cost of equity assumption of 16.5% to arrive at our FY10 target price of Rs34. We factor in upside from the RIL contract, which we expect to materialize only in FY11.
Our target price implies a multiple of 7.6x over FY10 EBITDA – a premium to a multiple of 4.2x that we assign to GAIL’s transmission business, as we believe that GSPL’s ROCE will increase from current levels under new regulations while GAIL’s gas transmission ROCE will decline.
We assume the charity contribution of 30% of PBT for GSPL in all our estimates. However, without this contribution, our target price would be Rs47 per share.
We initiate coverage with a BUY rating.