GUJARAT STATE PETRONET LTD (GSPL)

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1 COMPANY UPDATE Sumit Pokharna GUJARAT STATE PETRONET LTD (GSPL) PRICE: RS.113 RECOMMENDATION: ACCUMULATE TARGET PRICE: RS.124 FY16E P/E: 10.7X Softening of RLNG prices will revival industrial gas demand. We expect Gujarat State Petronet's earning to improve on account of both higher gas volumes and recent upward revision in gas transmission tariffs. Softening of LNG prices will revive demand in Industrial and power sector, we opine. Currently, RLNG accounts for ~85% of GSPL's total transmission volumes. We recommend ACCUMULATE (earlier BUY) on GSPL with a revised target price of Rs. 124/Share (Rs.109 earlier), given reasonable valuations at 10.7x PE based on FY2016E earnings. Summary table (Rs mn) FY14 FY15E FY16E Sales 10,507 11,701 13,877 Growth (%) EBIDTA 9,288 10,308 12,098 EBIDTA margin (%) PBT 6,599 7,728 9,065 Net profit 4,192 5,023 5,984 EPS (Rs) Growth (%) CEPS (Rs) BV (Rs/Share) DPS (Rs) ROE (%) ROCE (%) Net Cash (debt) (8,844) (6,565) (4,844) NWC (Days) EV/Sales (x) EV/EBIDTA (x) P/E (x) P/BV (x) P/CEPS (X) Source: Company, Kotak Securities - Private Client Research Price chart Source: Bloomberg Key Arguments Fall in RLNG prices along with crude oil prices is meaningfully positive for GSPL Asian liquefied natural gas (LNG) prices have fallen to its lowest level in nearly four years despite strong winters mainly due to strong additional LNG supply and stagnant LNG demand from Japan and South Korea (region's largest buyers). LNG prices have fallen below $10 per million British thermal units along with fall in crude oil prices. Just to highlight, ~176 million metric tons (MMT) of LNG is bought and consumed in Asia out of the total traded ~235 MMTPA LNG, globally. In 2015, major new LNG supplier will be Australia, which is expected to add LNG supplies from at least three new projects Chevron Corp.'s Gorgon project, Santos Ltd.'s Gladstone project and Origin Energy Ltd.'s Australia Pacific LNG project. This can put further pressure on the LNG prices unless demand revives. Further, two of Japan's nuclear power reactors are expected to restart in 2015, further lowering LNG demand. Other countries including India, China and Thailand have been purchasing LNG at low prices. We believe GSPL to benefit meaningfully with lower LNG prices. Currently, re-gassified LNG constitutes ~85% of its total volumes. Gas transmission volume revival In H1FY14, GSPL's gas transmission volume increased by 7% to 4,250 MMSCM (i.e mmscmd) due to softening of RLNG prices and industrial demand revival. In H2FY15, we expect the gas demand to increase further due to further softening of prices and revival in industrial activity. We expect GSPL to transport ~23.39 MMSCMD of natural gas in FY15E and ~26 MMSCMD in FY16E. In 2015, gas transmission growth is expected from ONGC Petro-additions Limited (OPaL) (~1.2 mmscmd) and Essar Oil (~1.1 mmscmd) amounting to ~2.3 mmscmd, with take or pay clauses. Further, gas price pooling proposal, if implemented, can add mmscmd to Gujarat state gas supplies and lead to considerable volume growth for GSPL. Valuation & Recommendation We expect GSPL to report an EPS of Rs.8.8 and cash EPS of Rs.12.3 for FY15E and similarly an EPS of Rs.10.6 and cash EPS of Rs.14.3 for FY16E. We recommend ACCUMULATE on GSPL with a revised target price of Rs. 124/Share (Rs.109 earlier), given inexpensive valuations at 10.7x PE based on FY2016E earnings. Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been prepared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 2

2 Key risk remains - margins to be capped at 12%post tax ROCE PNGRB has already stated its intent to cap the cross country natural gas pipeline returns at 12% post tax ROCE or 18.18% pretax ROCE. However due to lack of clarity from PNGRB, GSPL continues to charge such high tariffs for transportation of natural gas through its pipelines. Going forward the major growth in GSPL is expected to come from inter-state pipelines across Gujarat, Rajasthan, Maharashtra and Andhra Pradesh. Thus, its returns are expected to be capped in the near term. Key highlights LNG re-gasification infrastructure will ensure gas supply in India The growth of GSPL is tied in with the way India's gas supplies develop. We believe in the short-run the growth will be fueled by imported RLNG and in the longer-run it will be supported by both RLNG and domestic gas. Asian liquefied natural gas (LNG) prices has fallen to its lowest level in nearly four years despite strong winters mainly due to strong additional LNG supply and stagnant LNG demand from Japan and South Korea (region's largest buyers). LNG prices have fallen below $10 per million British thermal units along with fall in crude oil prices. Just to highlight, ~176 million metric tons (MMT) of LNG is bought and consumed in Asia out of the total traded ~235 MMTPA LNG, globally. In 2015, major new LNG supplier will be Australia, which is expected to add LNG supplies from at least three new projects Chevron Corp.'s Gorgon project, Santos Ltd.'s Gladstone project and Origin Energy Ltd.'s Australia Pacific LNG project. This can put further pressure on the LNG prices unless demand revives. Further, two of Japan's nuclear power reactors are expected to restart in 2015, further lowering LNG demand. Other countries including India, China and Thailand have been purchasing LNG at low prices. We believe GSPL to benefit meaningfully with lower LNG prices. Currently, re-gassified LNG constitutes ~85% of its total volumes. We have evaluated the potential LNG supply in India over the next few years FY20E. Based on this, we believe RLNG can provide India a solution to its rising gas demand and falling domestic gas production. We forecast a huge amount of new LNG liquefaction capacity to be added over the next few years. In the near term, we expect incremental RLNG supply from Kochi terminal. The following are the re-gasification terminals that are planned in the near future in India: India's RLNG capacity to boost significantly over medium to long term Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 3

3 Existing and proposed LNG import capacity in India (mtpa) Capacity Expected Capex (mtpa) completion (Rs Bn) Comments Existing Petronet-Dahej 10 Operational Shell-Hazira 5 Operational RGPPL-Dabhol 5 Operational Low utilization until breakwater facility is ready by Petronet-Kochi 5 Operational 45 Low utilization given delays in pipeline connectivity Total 25 Expansion/new projects GAIL, APGIC, GDF Suez (FSRU) 4 CY MoU signed between Kakinada Sea Ports Limited and APGDC Shell-Kakinada (FSRU) 5 CY Draft environmental impact assessment report submitted Petronet-Dahej 5 2HCY16 37 Second jetty to add 2 mtpa of capacity by May 2014 GSPC, Adani-Mundra 5 CY Consortium looking for a third partner Petronet-Gangavaram 5 CY Pre-project activities completed; short-listing of EPC contractors started Shell-Hazira 5 CY2017 Proposed expansion of existing terminal IOCL-Ennore 5 CY Leasing of land of Ennore Port Ltd. approved by Union Cabinet IOCL-Dhamra 5 CY MoU signed between IOC and Dhamra port company ONGC-Mangalore 5 CY MoU signed between ONGC and Mitsui to conduct feasibility studies HPCL, Shapoorji Pallonji-Chhara 5 54 Detailed feasibility study for technical and commercial viability underway GSPC, Swan Energy-Pipavav 5 FEED underway for an FSRU GSPL-Sikka 5 DFR contract awarded to Technip Total 59 Source: Company, Indian Petro. Indian companies have signed several long-term contracts over the past two years Long-term LNG supply contracted by Indian companies (mn tons) Supply Period Price Date Company (mtpa) (years) linkage Comments GSPC Mar-13 BG Group Expected to start from 2015 PLNG Apr-13 United LNG 4 20 Henry Hub Signed preliminary agreement; binding contract by end-cy2013 May-09 Exxon Mobil Crude oil Supply from Gorgon LNG terminal beginning 2015 Jul-99 RasGas JCC crude Supply started from 2004 Total 12.9 GAIL Apr-13 Dominion Henry Hub Contracted liquefaction capacity from 2017 onwards Oct-12 Gazprom Crude oil Expected to start from Dec-11 Cheniere Henry Hub Supply from Sabine Pass terminal beginning 2017 Total 8.3 Source: Company, Industry data In the short to medium term, we expect the domestic gas demand will be met mostly from imported RLNG. Currently, India imports more than a quarter of its natural gas requirements. As per projection, India will have ~ 59 MMTPA RLNG capacities by FY18 from its current level of 25 MMTPA capacities. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 4

4 Key assumptions behind the earnings model of GSPL Gas transmission volumes In H1FY14, GSPL's gas transmission volume increased by 7% to 4,250 MMSCM (i.e mmscmd) due to softening of RLNG prices and industrial demand revival. In H2FY15, we expect the gas demand to increase further due to further softening of prices and revival in industrial activity. We expect GSPL to transport ~23.39 MMSCMD of natural gas in FY15E and ~26 MMSCMD in FY16E. In 2015, gas transmission growth is expected from ONGC Petro-additions Limited (OPaL) (~1.2 mmscmd) and Essar Oil (~1.1 mmscmd) amounting to ~2.3 mmscmd, with take or pay clauses. However, we expect a major decline in gas volumes in FY18E with the commissioning of RIL's petcoke gasification project, which will substitute the requirement of re-gasified LNG, currently used in its refineries. Further, gas price pooling proposal, if implemented, can add mmscmd to Gujarat state gas supplies and lead to considerable volume growth for GSPL. In the last few quarters, the gas sales volumes of the entire industry has fallen due to lower domestic gas supply and higher price of imported LNG. The same can be seen in the below mentioned chart. However, we believe the trend will reverse in the medium to long term. Gas transimission volume for the industry. GSPL's transmission volumes increased Source: Company In the medium term, a favorable LNG price scenario (on back of new import facilities and opening up of LNG markets) will aid volume growth. Additionally we expect the cross country pipeline project helping the company in the long term (4-5 years) to significantly expand the business beyond Gujarat. APTEL order to bring in tariff upsides Appellate Tribunal for Electricity (Aptel) has set aside GSPL's tariff order of 2012 and remanded back the matter to Petroleum & Natural Gas Regulatory Board for reconsidering tariff based on relevant data, ensuring a just and reasonable post tax RoCE of 12% and protecting commercial interests as well. However, APTEL has not made any specific comment on various contiguous issues like system usage of gas, common carrier capacity, depreciation, inflation, and carrying value of assets. This is a positive development for GSPL and will improve its tariffs. The benefit of the same will be reflected in Q3FY15 and onwards. Gas transportation tariffs: We have modeled gas transmission tariff of Rs. 1.35/Mscm in FY15E, Rs.1.4/Scm in FY16E and Rs. 1.4/Mscm in FY16E. The expected higher tariffs in FY2015 reflecting upward revision in tariffs. In H1FY15, the implied tariff has increased to Rs. 1.3/ MSCM. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 5

5 Key triggers for stocks: 1). Clarity about tariff 2). Commissioning of the gas transmission pipeline and 3). Ramp-up in gas supply Key risk remains - margins to be capped at 12%post tax ROCE PNGRB has already stated its intent to cap the cross country natural gas pipeline returns at 12% post tax ROCE or 18.18% pretax ROCE. However due to lack of clarity from PNGRB, GSPL continues to charge such high tariffs for transportation of natural gas through its pipelines. Going forward the major growth in GSPL is expected to come from interstate pipelines across Gujarat, Rajasthan, Maharashtra and Andhra Pradesh. Thus its returns are expected to be capped in the near term. We recommend ACCUMULATE on Gujarat State Petronet with a price target of Rs.124 Valuation & Recommendation We expect GSPL to report an EPS of Rs.8.8 and cash EPS of Rs.12.3 for FY15E and similarly an EPS of Rs.10.6 and cash EPS of Rs.14.3 for FY16E. We recommend ACCUMULATE on GSPL with a revised target price of Rs. 124/Share (Rs.109 earlier), given inexpensive valuations at 10.7x PE based on FY2016E earnings. GSPL has invested Rs. 3.5 Bn in Gujarat Distribution Network Ltd (GDNL) for a 40% stake (GDNL holds 74% stake in Gujarat Gas). GSPL also holds 29% stake in GSPC Gas, which holds 60% stake in GDNL, thus effectively taking GSPL's stake in Gujarat Gas to 42.5%.We have not taken the valuation of the CGD business into consideration while valuing GSPL. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 6

GUJARAT STATE PETRONET LTD (GSPL)

GUJARAT STATE PETRONET LTD (GSPL) COMPANY UPDATE Sumit Pokharna sumit.pokharna@kotak.com +91 22 6621 6313 Summary table (Rs mn) FY13 FY14E FY15E Sales 11,732 11,598 10,365 Growth (%) 4.4-1.1-10.6 EBIDTA 10,721 10,648 9,722 EBIDTA margin