Petronet LNG Limited - Green India with Clean Fuel

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Petronet LNG Limited (https://www.petronetlng.com/Company.php)

Company Overview

Petronet LNG (PLNG) is the market leader in the LNG receiving and regasification business in India. The company has set up the country’s first LNG receiving and regasification terminal at Dahej, Gujarat, and another terminal at Kochi, Kerala. While the Dahej terminal has a nominal capacity of 15 MMTPA, the Kochi terminal has a capacity of 5 MMTPA. The company is in the process to build a third terminal at Gangavaram, Andhra Pradesh. A couple of other important plants are also in the plans.

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Formed as a Joint Venture by the Government of India to import LNG and set up LNG terminals in the country, it involves India’s leading oil and natural gas industry players. Their promoters are GAIL (India) Limited (GAIL), Oil & Natural Gas Corporation Limited (ONGC), Indian Oil Corporation Limited (IOCL) and Bharat Petroleum Corporation Limited (BPCL).

Business Overview

To put it shortly, PLNG’s business follows the below cycle:

  1. Sign long term, fixed price contracts with gas suppliers from overseas. Currently, they have signed such contracts with Gaz de France and Ras Laffan LNG Company.
  2. Process the purchased gas in liquefaction plants
  3. Store them in LNG storage tanks.
  4. Sell them to Oil & Gas clients, after which the gas will be vaporized and transported via gas pipelines. The buyers are largely IOCL, BPCL, GAIL and ONGC as of now.

PNG

Industry Overview

The quest for alternative fuel has been a common denominator in most parts of the world. Closer in Asia, India and China have been spear-heading the change.

Even if India were to simply move towards the global average power mix, it would still mean a massive shift towards gas:

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PLNG’s direct competitor, Shell, came out with a statement expressing their enthusiasm about the LNG market prospects in India:

Other news articles also follow through:

https://www.lngworldshipping.com/news/view,lng-in-india-in-with-the-new_54423.htm

But in fact, the overarching story is that the Supply-Demand situation for gas in India is highly skewed. Supply is only a fraction of the projected demand:

DS

Considering how the domestic gas supply isn’t up to the mark, LNG imports will have to be boosted to fill in the gap.

Business Analysis - SWOT

Strengths

  • PLNG has the highest market share in this space and can play a huge part in bridging the demand-supply gap in LNG imports and regasification.

  • PLNG already has large plants at low capacity utilization levels. If the demand for imported gas indeed picks up, the operating leverage can kick in to aid profitable growth.

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  • PLNG is also largley the face of India’s LNG import talks with foreign nations. So if there’s a list of companies that can successfully discuss profitable LNG import deals for the country, PLNG would probably figure at the top of the list.

Weaknesses

  • When all is said and done, the regasification business is a commodity business and therefore, reliant on supply and demand of raw material (Here, gas). Any high-demand situation in gas abroad can dent PLNG’s margins quite easily. However, currently, the prices seem to have stabilized.
  • Since the firm largely supplies to the Oil & Gas giants of India, bargaining power with customers is non-existent. On the other hand, the firm imports gas based on long term fixed-price contracts. So once again, bargaining power with suppliers is also quite less.

Opportunities

  • As already discussed, the upcoming push towards green energy and a lack of local gas production offers a lot of value to the company on a golden plate. It’s only a matter of how large a piece of the pie the company can claim for itself.
  • The company has also been applying (Although highly unsuccessfully) for City Gas Distribution License (Source 1, Source 2). If PLNG could somehow win a license, it will mark a foray into a new, prosperous, challenging segment with its own set of opportunities.
  • In the past few years, the company has been negotiating gas import contracts with more suppliers (Exxon in Australia, Henry Hub in USA to name a few). Done successfully, this will spark a price war and hopefully, PLNG can get their raw materials at a cheaper price. The diversification of raw material sources also comes as an advantage.
  • If and that’s a big if, PLNG can negotiate shorter term contracts instead of long term contracts, raw material prices can come down significantly. My memory slips where I read this exactly, but the difference could be as much as 50% lower.

Threats

  • A great profit opportunity attracts several competitors and the regasification business is no exception. PLNG’s capacity to supply far exceeds the competition. But it is always good to look out for dark horses.

Financials

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Mandatory linking to Screener. But I sincerely suggest that you check out the report by Ventura. They have done an excellent dissection of the numbers related to the business.

Valuation

In my opinion, depsite the run-up in the stock’s price, it looks to offer some value.

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However, please note that the above valuation is done at a Cost of Capital of ~12.5% and a Margin of Safety of 30%, both of which I think are not enough. Considering the commodity nature of the business, these should be a tad higher. So a valuation tainted by my personal risk-reward opinion would look like this:

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TLDR is, PLNG is not my cup of tea. But it could be yours, depending on your own risk-reward tendency.

Red Flags / Risks

  • PLNG is a state-owned entity. So, there is no question of Corporate Mis-governance here. But of course, the same fact also appears as a red-flag. We know the fate of several state-owned entities being the playthings of politicians. It is not too farfetched to assume that PLNG could join the pack during the upcoming flood of LNG demand.
  • 50% PLNG is owned by 4 Indian Oil & Gas giants. Not only do they own 50% of the company, but they also sit on the board of the company (Talk about independence of the board). The cherry on the cake, these four entities are also the sole customers of the company (Well, almost). You can probably do the rest of the math.

Disclosure

I do not hold any position in Petronet LNG.

Important References

PLNG’s Annual Reports
Ventura Research on PLNG (A MUST READ research report on PLNG)
PLNG’s Corporate Presentation
Petronet LNG - Wikipedia
List of LNG Terminals in India

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Thanks for this writeup, Dinesh. Very thorough. The Ventura report was quite good indeed. A few comments:

Disclosure: I hold Petronet LNG in my portfolio.

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Yes, that’s true. But I think the bigger picture should be to think about how much the government wants to switch to alternative fuel. If they want to, these hurdles will be resolved in due time.

It’s mentioned in the article itself. Due to poor demand. Like I said in the original post, despite the tailwinds and structural advantages, we should not forget the fact that PLNG is still largely a commodity business. Supply and Demand impacts its profits quite easily.

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It appears it’s not that ‘end-use’ demand is the issue. I believe that is there and will grow. It is the downstream infrastructure that’s a problem - the Kochi-Mangalore pipeline, for instance.

This is a good article that illustrates the issues nicely - https://in.reuters.com/article/india-lng-imports/india-lng-demand-journey-to-be-shaky-slow-due-to-infrastructure-limits-idINKCN1QV3AY

If we consider China’s case, China’s use of natural gas has already exploded, and is likely to grow even more (as this article says - https://www.forbes.com/sites/arielcohen/2019/01/17/china-to-quadruple-lng-imports-will-u-s-exporters-benefit/#18c655ca2102). We will possibly follow the same path, even if not to the same degree.

Of course, ‘price’ remains the key factor when it comes to PLNG’s profitability. Agree fully there.

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Yes, this is the ‘varied sourcing’ that I was talking about in the ‘Opportunities’ section. This will increase Margins temporarily. However, if the suppliers reduce their supply rate one after the other, a price war can indeed be even more beneficial.

In the future? Yes. Bad infrastructure can dent growth. But the article you shared earlier talks about the current demand and supply situation. It says consumption has decreased YoY due to limited demand.

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Very well summarized writeup, Dinesh. I have not been able to spend time on Valuepickr lately, but could not resist the temptation to read another analysis from you. Significant part of my portfolio contained Petronet (around 30%) but I recently sold-off during recent runup - may buy it back if it falls to a reasonable valuation - thus my views can be biased.
My conviction is based on the factors you mentioned above - demand growth prospects are very clear, its a leader in the industry - thus has necessary contacts, customers and expertise, new capacity additions planned, good financials and dividend yield. I slightly differ with you on the view of pricing - in the value chain they are best placed to pass on the cost to customers. They seem to be always renegotiating gas contracts, diversifying them and now getting into buying some long term gas assets - so not a typically government run company. Diversifiying business in other regions.
My concerns are - speed of capacity growth is its bottle neck - it takes a long time to add new capacity and thus profit is then limited to capacity utilization and pricing action. Overcapacity risk in Industry as the infrastruture growth on the demand side is still very slow - some competitors are even planning to differ capacitiy addition. Since most of the capacity is in a single location any accident or evironmental impact will be catastrophic to this company.

For me, this company is a consistent value creator (expecting 10-12% growth YoY) with its own set of opportunities and risks.

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The ‘customers’ are, as I have mentioned, the 4 biggest Oil & Natural Gas players in India. They are also the board members and shareholders (50% together) in the company. It is naturally conflicting that they will allow PLNG to pass on a lot of cost to them, because after all, they hold a stake in the company. I’m not saying they will misuse their position in the company’s board, but it should be a consideration for risk.

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Some industry tailwind. If the management is planning any tactics, this would be the time to execute it.

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Thanks for starting the thread @dineshssairam.

I have some additional pointers / follow-up questions to take the discussion further.

  1. Why did the company build the Kochi terminal if there were no prospects of piping the gas to industries in Mangalore? How did the due-diligence before implementing the project miss this?
  2. Are the pipelines from Gangavaram project already laid out? Ventura report’s map suggests there is an authorized pipeline from Gangavaram, which connects to Rest of India. But the map also includes the Kochi-Mangalore pipeline which is not in usable state. How certain are we that the Gangavaram terminal will not face issues similar to the Kochi terminal?
  3. How are the pricing contracts designed with our customers? Is it fixed on full sale price per unit or is it fixed on re-gas price per unit?
    Ventura report says re-gas. Does that mean we are hedged from the price swings of LNG in the market? If fixed on re-gas per unit price, then do we have the ability to pass on LNG price increases / decreases to our customers?
    If we are able to pass on the LNG volatility to our customers, we can have confident estimates on EBITDA / ROCE (not revenues / costs), as EBITDA would be hedged from LNG price swings.
  4. The trend of re-gasification charges from Ventura report look awesome. This coupled with expected LNG volume growth looks great. Would love to check if there are other sources to double check the re-gas prices mentioned here. Please share if you have any.
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  5. Below article mentions that the Govt wants the company to be identified as a Private company so that it can avoid CAG Audit and Parliament Scrutiny, though for all practical purposes, it is a public sector company. What’s CAG Audit and what’s benefit of avoiding it?
    France’s GDF to exit Petronet by selling entire 10% stake - The Hindu BusinessLine
  6. Ventura report mentions about the capex on CGD. Did PLNG communicate about the CGD venture directly to shareholders through any official investor resource? At the same time, I do trust Ventura’s report as I see Petronet’s bids for few GAs in the tenth round of bidding. Anyways, they didn’t win any bid.
    http://www.pngrb.gov.in/pdf/cgd/bid10/Sheet1_08022019.pdf
    http://www.pngrb.gov.in/pdf/cgd/bid10/Press%20release_01.03.2019.pdf
  7. Any number on the maintenance capex for the company, provided by management in some conf calls? Should help us compute FCF.

Disclosure: Not invested, but quite interested in studying further

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Something as big as this is never easy. There has been protests in Malabar and the recent delay can be owed to poor Project Management. I think it will eventually happen. It is immensely beneficial to India as a nation. But yes, the delay is costing precious time and money to both GAIL and all related players (Including PLNG).

The Gangavaram one is still in progress. This is the latest citation I could find (Dec 2018):

The Kochi terminal has a capacity of 5 MTPA. The company is in the process of building a third terminal, at Gangavaram, Andhra Pradesh.

Fixed contracts. This is written expressly in their Annual Report. Makes sense, because their sourcing is also via Long term fixed contracts.

The sole activity is the import and regasification of LNG. PLL has sourced LNG under long-term contract from RasGas of Qatar and has sold re-gasified LNG mainly to three intermediate off-takers, namely, GAIL (India) Ltd., Bharat Petroleum Corporation Ltd., and Indian Oil Corporation Ltd. PLL has long-term gas sale and purchase agreements with these reputed companies.

I’m not sure why the Ventura report says otherwise.

Yes, essentially. However, as this thing ramps up, I suppose there may be some government intervention. Or worse, there could be a cartelling among buyers. This is a key risk I mentioned in the original post.

Oh, very interesting. I am not sure of the benefits to this. But it doesn’t sound very minority-shareholder-friendly to me. I will say it again. If there’s more honey to be stocked, it will attract the flies. And if it’s a PSU, we don’t even need to ask.

Yes, they have been bidding for gas distribution. Here’s a news article on it:

Actually, thanks for reminding me. I forgot to add this in the ‘Opportunities’ section.

Just looking at the Fixed Assets Purchased from 2-3 years back should give us this. Historically, I can see that this has been about 1-2% of Sales. But I doubt this will help you calculate the future FCF, since we also need to account for all the upcoming large Capex. But this figure is very elusive, since we don’t know for sure if it will happen (Thanks to all the WIP). That’s why in my valuation, I have chosen to claim a massive MoS. There are too many unknown variables.

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As I study further, I have more apprehensions in investing in the company.
Though the company might give good returns in the future, I’m unable to comprehend the amount of risk involved.
Look at below screenshot, Management says “have some good economic ties with the SAARC nations, so we are simply furthering the objective of Government of India also and, of course, the commercial consideration, returns all these are to be ensured while doing all of these things”

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Some food for thought:
What is the top priority for the company? SAARC Relations or Shareholder returns?
Even if it is shareholder returns? What would the management choose between the three scenarios here?
a. 25% Returns + Uncordial relations with SAARC
b. 20% Returns + No change in relations with SAARC
c. 15% Returns + Cordial relations with SAARC

Hope there is a listed non-govt player in the same field who can capture this huge opportunity…

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When it comes to govt companies I tend to stay away because even if the opportunity size is substantial, a govt company doesn’t work with absolute profit motive. The first motive is to advance govt’s agenda. In PLNG’s case, that agenda is increasing penetration of Natural Gas usage in the country. Whether PLNG makes or loses money in the pursuit of this motive is not an immediate consideration. It might be an incidental one though !
Even though PLNG today has the advantage of being the cheapest cost per unit regasifier in the country with the largest live capacity in the space, it is impossible to estimate it’s competitive advantage period because govt action is unpredictable and uncertain.
I see PLNG as eventually turning into an oil utility like the IOCL, HPCL with hefty dividends at the end but limited/no growth.
Be mindful also of the new Regasification capacity coming live by private players like Shell, H1 energy etc.

Disclosure : No investments

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This is negligible. Shell is coming up with 5 MMTPA and H-Energy also with 5 MMTPA. In comparison, PLNG’s Expected Capacity (When all the WIP is cleared) would be 27.5 MMTPA.

But otherwise, I agree with the ‘PSU risk’ part. I don’t think there was ever a single PSU in India that was allowed to create monumental value for shareholders. I suppose there could be 1-2 that created value simply based on cheapness. That’s about it.

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In fourth quarter of fy19 the company had short-term borrowing of Rs. 100cr and no long-term borrowing.

In first quarter of fy20 company paid 100cr as finance cost. First quarter results do not have balance sheet.

But did company borrowed close to 10,000cr in first quarter of fy20.

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