GSPL is a pure Natural Gas transmission company which owns and operates pipeline network in Gujarat on open access basis. Most of the customers are natural gas end-users who purchase NG from upstream suppliers, such as marketers, producers and importers, and use GSPL’s gas transmission network to transport the NG to their location. The company does not take title of the natural gas that it transmits and therefore does not assume any natural gas commodity price risk. Suppliers and end-users enter into a gas sales agreement (GSA) that specifies the quantity of natural gas, price and other commercial terms. Since large quantities of natural gas can only be transported by pipelines while it is in gaseous form, either the user or the natural gas supplier must enter into a gas transmission agreement (GTA) with a natural gas transportation company such as GSPL to transport the natural gas from the supply source to a point where it can be utilised. The GTAs that GSPL enters into with the customers designate the entry and exit points for the natural gas as it travels through the gas transmission network and provide for terms such as tariffs, tenure and capacity reserved in the gas transmission network.These GTAs have ‘take or pay’ clause, which implies that the customers have to pay a fixed charge even if there is no gas transported during the contract period. Transportation tariffs are the revenues for GSPL which are made of two components, a fixed fee for blocking the capacity(~90% of total tariff) and transportation charges linked with actual amount of gas transported. ‘Take or pay’ model provides earnings visibility for GSPL and being a pure transmission player they do not have any exposure to commodity price risk.

Growing with ‘Gujarat’ (Natural Gas capital of India)

Gujarat is the fastest growing state in India with contribution of ~16% in total industrial output in India. It accounts for ~21% of India’s exports and has attracted ~22% of investments in India. GSPL started its journey from Gujarat and is expanding its pipeline network aggressively to cover complete Gujarat in next 2-3 years.Gujarat currently accounts for around one-third of total natural gas consumption in India. Promotional events like Vibrant Gujarat for attracting investment, planned Mumbai-Delhi freight corridor and high industrial growth rates translate into higher demand of natural gas in Gujarat.

GSPL is connected to major gas domestic and import supply source like, KG Basin, PMT, Petronet LNG - Dahej, Shell-Hazira. The company has laid the network of ~1700 kms of gas pipeline with capacity of more than 45mmscmd. Its operation ranges from Hazira-Vadodara-Ahmedabad- Kalol-Himmatnagar-Mehsana-Rajkot-Morbi-Anjar-Jamnagar. It is further expanding its network to cover complete Gujarat targeting ~2400kms of pipeline network in the next 2-3 years.

Benefiting from increasing gas availability

Surge in domestic gas availability post Reliance KG-D6 discovery changed the natural gas dynamics in India. In the past, contribution of natural gas has always remained subdued in the India’s energy basket as compared to global average. However, government policy initiatives, new indigenous discoveries and increasing LNG imports augur well for natural gas sector considering higher contribution from natural gas in the future energy mix. Thus, it shall provide an impetus to natural gas transporting companies.GSPL being the 2nd largest gas transporter (GAIL is the largest) and presence in Gujarat benefited with the increasing gas availability in India. Volume transported by GSPL increased at a CAGR of ~28% from FY05 to FY11 as against total gas availability CAGR of ~10%.

Expansion provides long term visibility

Expansion in Gujarat: GSPL has a network of ~1700 kms of gas pipeline with capacity more than 45mmscmd in Gujarat. Its operation ranges from Hazira-Vadodara-Ahmedabad-Kalol- Himmatnagar-Mehsana-Rajkot-Morbi-Anjar-Jamnagar. It is further expanding its network to cover whole Gujarat with targeting ~2400kms (capacity of 55-60mmscmd) of pipeline network in the next 2years. The customers of GSPL comprise of industries such as power, fertiliser, steel, chemical plants and local distribution companies. Along with trunk line, GSPL continues to develop spur lines to connect uncovered industrial clusters and medium-size customers. Ongoing expansion in Gujarat provides growth visibility for the company for the next 2-3 years. We expect additional volumes of gas to come from ramp up of RIL KG-D6, GSPC & ONGC’s KG block, and increased LNG supplies. Our volume assumption for FY12 and FY13 are 39.2mmscmd (+10.2% YoY) and 45.3mmscmd (+15.5% YoY) respectively.Foray beyond Gujarat boundaries: While the expansion in Gujarat provides short-term growth visibility, foray into inter-state pipeline offer long term growth visibility. GSPL submitted EOI for four pipelines in consortium (GSPL-52%, IOC-26%, BPCL-11%, HPCL-11%).

GSPL has been awarded two cross country pipelines i. e. Mehsana-Bhatinda and Mallavaram- Vijapur-Bhilwara in the bidding process. Details related to total capex and transportation tariff are not yet announced, however, we expect GSPL’s bid to be on aggressive side. These pipelines should be commissioned by 2015. We believe, huge capex and muted volume outlook initially for these new pipelines should not be taken negatively as GSPL is trying to expand beyond Gujarat territory rather than being satisfied with leadership position in Gujarat

Robust Financials

Volume growth with sustained tariff

Volume: Post gas supply from RIL-KGD6 basin, GSPL’s transportation volumes increased by 115% YoY to 32mmscmd in FY10. With slower ramp-up of RIL KG D6 gas volume, we have taken only 10.2% growth in FY12. However, we expect volumes to ramp up from FY13 onwards with more gas availability from KG basin (RIL, GSPC, ONGC fields) and higher LNG imports.

Transportation Tariff: Prior to PNGRB’s regulation related to network tariff, GSPL’s pipelines tariff were on higher side. Taking corrective measure post PNGRB policy announcement, GSPL decreased its tariff from Rs900/ tscm in FY09 to Rs780/ tscm in FY11. The tariffs are under consideration by PNGRB but we believe that company should be able to maintain tariff at Rs750/tscm in future with their ongoing expansion in Gujarat. It is expected that GSPL should have a network of 2400km in Gujarat in next 2 years.

Due to muted volume growth (slow ramp-up of RIL gas) and decreased tariffs, net sales and net profit should grow at CAGR of 7.7% and 12.3% from FY10 to FY13 respectively. Profit is growing at a higher rate due to change in depreciation policy (GSPL has reduced depreciation rates from8.3% to 3.3%).

Robust cash flow from operation to support aggressive capex

GSPL increased its gross block by ~4x to Rs33bn in last 5 years. The company has aggressive plans to have capex of ~Rs18bn from FY11 to FY13 to cover entire Gujarat with their pipeline network.

GSPL has positive cash flow from operation (CFO) and should be sufficient to take care of incremental capex in Gujarat and planned foray into cross-country pipelines. As per our estimate, total CFO for FY11 to FY13 should be Rs21.5bn and hence even after ongoing aggressive capex its net D/E should decrease from 0.7x in FY10 to 0.5x in FY13.

Change in depreciation policy to boost returns Being a pure transporter without any title of gas transported, GSPL enjoys high operating margins at ~92.5%. We expect OPM to remain at these levels as we see 10-15% volume growth in future and network tariff at Rs750/ tscm.

GSPL has changed its depreciation policy in Q3FY11. Now depreciation will be charged assuming the life of pipelines as 30 years from earlier assumption of 12 years. This should result in ROCE and ROE to remain at ~22% levels achieved in FY10 despite ongoing aggressive capex.

Indirect presence in booming CGD space

GSPL has indirect exposure into high growth CGD (City Gas Distribution) business which is a natural integration from its transportation business. The company has acquired equity in two CGD players, GSPC Gas Co Ltd and Sabarmati Gas Ltd. Both are Gujarat based players and have combined volume of ~4mmscmd (GGAS is largest player in CGD with ~3.5mmscmd of volume).

CGD business is expected to grow exponentially in the future with availability of more natural gas & their favourable dynamics over other competitive fuels. GSPL should benefit with its stake in the above CGD companies.

Wind Energy – Tax benefit

GSPL has initiated 52.5 MW wind power project in the areas of Maliya Miyana, Rajkot and Gorsar, Porbandar. 6MW wind power generation was achieved in FY10 and balance 46.5MW capacity is expected to get commissioned in FY11. The investment of Rs3.2bn in wind energy will result in tax benefits for GSPL.

For our DCF, we have taken risk free rate of 8%, market premium of 6% and terminal growth rate of 3%. Beta for GSPL stands at 0.85.

NPV from new inter-state pipelines – Not included in valuation

GSPL is awarded two cross country pipelines in Oct’10 through bidding process. Capex and network tariffs for these pipelines are not yet disclosed. Considering 12% post-tax return norms(prescribed by PNGRB) these two pipelines together contributes NPV of ~Rs25. However, we have not considered this upside in our target price till further clarity comes related to capex and pipeline tariff.

We expect natural gas proportion in India’s energy basket to increase in future. GSPL with leadership presence in Gujarat and foray in cross-country pipeline should benefit with the incremental volume. We have considered 3% as terminal growth rate for GSPL post FY15 for our valuation.

RECOMMENDATION

At the CMP of Rs100, the stock is trading at P/E of 11.3 & 9.6 and EV/EBITDA of 7.1x and 6.1x respectively for FY12 and FY13.We have valued the company based on discounted cash flow due to visibility in future revenues and ongoing huge capex. We recommend ‘BUY’ with a target price of Rs130 for 1 year time horizon. We have not considered any upside from two new inter-state pipelines (Mehsana- Bhatinda and Mallavaram-Vijaipur-Bhilwara) awarded to GSPL. At our target price P/E and EV/ EBITDA stand at 14.7x and 8.8x respectively for FY12.

CONCERNS

Downward revision in Tariff

Post formation of PNGRB, returns for gas transporters are fixed at 12% post tax. However, prior to that decision on network tariff was in company’s control. GSPL decreased its tariff for Rs900/tscm in FY09 to Rs780/tscm in FY11. With ongoing expansion in Gujarat, GSPL is confident that their tariff will not go below Rs750/tscm. However, any negative surprise in terms of lower tariff rate will dent our EPS estimate and target price.

GSEDS contribution

According to Gujarat government earlier notification, all profit making PSUs have to pay 30% of their earnings towards Economic Development Society (GSEDS). Management has directed that such payments would be made only for projects approved under Section 35AC of the Income tax Act 1961, which would make it eligible for tax exemption. The management has clarified that no provisions would be made for this and payments would be made as and when projects are identified by the IT department. We have not incorporated any contribution for GSEDS and any provisioning in the future will be negative for our earning projections.

Slow ramp-up of domestic natural Gas

RIL KG-D6 gas output plateau at sub 60mmscmd level in FY11 and is expected to pickup only in FY13. We have considered the slow ramp-up of RIL gas and have taken only 4mmscmd additional gas volume in FY12 (+10.2% YoY) with additional supplies coming from imported LNG. Slower increase in natural gas volume in FY12/FY13 may dent our earning estimates and hence the target price.