Petronet LNG: Rising LNG prices a concern

The stock's high valuation seems to underestimate the risks of falling consumption demand

Rising spot prices of liquefied natural gas (LNG) could spoil the party for Petronet LNG, which has been a favourite of the Street after delivering healthy volumes in the September quarter. That spot LNG prices are trading closer to two-year high levels could weigh on LNG demand in India, say analysts. This, in turn, could impact Petronet’s volumes as well as financial performance going ahead. Rising LNG prices reduces its competitiveness versus other fuels such as naphtha. In fact, high prices have already started hitting consumption demand. LNG consumption from the power sector, for instance, declined 41 per cent on a month-on-month basis in October.
 
“With the resumption of Dabhol capacity after monsoons, Shell Hazira’s additional freed-up capacity and imminent commissioning of the Mundra LNG terminal in FY18, near-term upsides to capacity utilisation for Petronet’s Dahej terminal is constrained, in our view,” says Amit Rustagi, analyst at IDFC Securities. Notably, most analysts covering the stock are factoring in 100 per cent capacity utilisation at Petronet’s Dahej terminal in FY18, which could now be at risk.
 
With gains of 59 per cent in the past year, the Petronet scrip has been on a roll so far and commands rich valuation of 17 times FY18 estimated earnings. The valuation does not adequately factor in the risks emanating from rising spot LNG prices, and, hence, is susceptible to downsides from here on. On the flip side, ramp-up in use or pay contracts could provide some support to Petronet’s earnings and cap the earnings downside thereof.
 
Among Petronet’s key expansions, its Kochi pipelines might take two more years to complete; it could see lower losses once Bharat Petroleum’s Kochi refinery ramps up.
 
Petronet expects its Gorgon (Western Australia) facility to witness full ramp-up in July 2017. According to Credit Suisse analysts, given that Gorgon prices are 50-60 per cent higher than spot LNG, it will be challenging to sell in the Indian market.
In this backdrop, investors would keenly watch out for management commentary on the demand trends and the outlook from here on. The use or pay contracts lend visibility to Petronet’s earnings and drive expectations of 22-25 per cent compounded annual growth in its earnings over the next couple of years.
 
These expectations, however, could be toned down to factor in the recent weakness in consumption demand and weigh on Petronet’s stock price and valuations, say analysts.