GSPL: What is driving recent brokerage upgrades?

Softening LNG prices, improving visibility on transmission volumes will translate into a better financial show by the firm

Recent developments have provided multiple reasons to cheer the Gujarat State Petronet (GSPL) scrip, which made a new lifetime high of Rs 135.65 on Tuesday. GSPL is into transmission of natural gas to the industrial segment in Gujarat. The easing of liquefied natural gas (LNG) prices, upward revision in gas transmission rates in November 2014, and improved visibility on gas sourcing (gas price pooling, higher volumes from ONGC, Essar Oil) are the key triggers to this rally. Pricing in these positives, leading brokerages have upgraded the stock.

IDFC Securities, for instance, upgraded the scrip to outperform in December 2014. The brokerage expects GSPL to benefit from higher rates and a gradual increase in volumes via higher LNG capacity and softer prices. It believes after the merger, Gujarat Gas (GSPL has 26 per cent stake) will contribute Rs 2.6-3.3 earnings per share (EPS) to GSPL's FY17 estimated consolidated earnings. It also raised FY16 EPS estimates by 5.7 per cent to Rs 10.4.

Falling transmission volumes have impacted GSPL's financial health in recent quarters. Lower availability of domestic gas and muted demand for expensive spot LNG have hit volumes. However, the likelihood of better production from the KG-D6 block and adoption of a price pooling mechanism will provide higher visibility on volumes, which in turn will improve GSPL’s financial performance. The fall in LNG prices to $9.5 per million British thermal units (mBtu), lowest in the past four years, is a key positive for GSPL.

Weak prices could lead to higher demand. Weak oil prices along with unfavourable demand-supply equation will keep LNG prices under pressure as well. Currently, regasified LNG forms 85 per cent of GSPL’s total volumes. Analysts at Antique Stock Broking believe adoption of a gas price pooling mechanism could add at least 5-7 million cubic metres a day (mcmd) to Gujarat Gas' supplies and aid volume growth and EPS upside of Rs 1.3- 1.8 per share for GSPL.

From 27.3 mcmd in FY13, GSPL's gas transmission volumes fell to 21.1 mcmd in FY14 owing to limited gas availability. This trend is likely to improve in FY15 with full-year volumes pegged at 24.5 mcmd levels. This level is estimated to increase another 14 per cent to 28 mcmd by FY17.

After the Appellate Tribunal for Electricity order, analysts expect GSPL's tariffs to increase by 10 per cent from FY16 to Rs 29.2 an mBtu. A 10 per cent increase in average rates adds 15-16 per cent to GSPL’s earnings per share, estimate analysts. Improving volumes as well as rates will thus boost the overall performance of GSPL.

Given the improving growth prospects, most analysts remain positive on GSPL. Commissioning of the gas transmission pipeline and improved gas supply are some near-term catalysts for the stock.

The potential capping of natural gas pipeline's return on capital employed ratio to 12 per cent on an after-tax basis is a material downside risk going forward.