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Sunshine after the storm

“The good seaman weathers the storm he cannot avoid and avoids the storm he cannot weather.”

* The onset of Russia-Ukraine conflict brewed an unavoidable storm for Gujarat Gas (GUJGA) with spot LNG price spiraling to USD34.5/mmBtu in 1HFY23 from USD23.4/mmBtu in FY22. Brent also surged to USD107/bbl in 1HFY23, thereby escalating costs for GUJGA’s long-term, crude-linked contracts. The storm intensified further as Morbi’s ceramic cluster was shut down for a month in 2QFY23, thus severely impacting industrial volumes.

* As a result, PNG price rose to INR63/scm by May’22, before dipping to ~INR46/scm at present. Higher prices forced consumers, especially at Morbi, to switch to cheaper alternatives such as propane and LPG.

* However, the storm now seems to be running out of steam with spot LNG prices declining 48% from its peak. Addition of 18.1mmt of effective liquefaction capacity globally in CY23 (v/s 11mmt addition in CY22), could push gas prices further down, thereby making PNG lucrative than alternate fuels.

* We maintain our BUY rating on the stock with a TP of INR679 (based on 28x Dec’24E EPS). Slower-than-expected pick-up in volume or high gas prices adversely impacting both volume as well as margin can pose a key risk to our recommendation.

Production ramp-up to ease heated gas price

* Spot LNG price has cooled down notably to USD28.2/mmBtu in Dec’22 from the peak of USD54/mmBtu in Aug’22, led by higher gas production coupled with lower demand due to warmer-than-usual winter in the US/Europe as well as gas rationalization in Europe.

* According to EIA, the US gas production clocked an all-time high of 100bcf/d during Oct-Nov’22. Gas production is likely to increase further by ~2% YoY to ~100-101bcf/d in CY23 driven by intensified drilling activities in the Permian and Haynesville regions, which can further depress gas prices. Domestic gas supply is also set to rise ~12mmscmd (RIL)/~10mmscmd (ONGC) over the next few months.

* Additionally, according to IGU, global liquefaction capacity is poised to expand by another 18.1mmt in CY23 after increasing 11mmt in CY22. This should exert further downward pressure on spot LNG prices. To give a perspective, the EU imported ~117mmt of gas from Russia in CY21.

Alternate fuels only a 3-4 month seasonal risk

* We examined historic prices over the last eight years to analyze the cost competiveness of LNG v/s LPG and propane.

*As spot volumes can vary markedly depending upon supply-demand dynamics, we consider blended LNG prices under multiple scenarios of spot volume mix. We assume long-term LNG to be procured at 14% slope to Brent.

* Our analysis reveals that LNG on an average has been cheaper by 15%/19% than propane/LPG when the entire demand is met through long-term contracts.

* Even when 30% of demand is met through spot volumes, LNG continues to be cheaper by 10%/15% than propane/LPG. Whereas, it is cheaper by 14%/18% than LPG/propane if 10% of demand is met through spot volumes.

* Barring the current flux in gas markets, LNG should continue to remain cheaper than alternate fuels by similar magnitude, except for 3-4 months in a year.

Trading at reasonable valuations; maintain BUY

* GUJGA can raise volumes through several avenues such as Ahmedabad rural, Amritsar, Bhatinda, and Thane rural in addition to the growth that would come from industrial/CNG pick up in the existing areas.

* GUJGA has an RoCE of ~25%. We expect an FCF generation of ~INR17b over FY23-24. The company is likely to turn net cash in FY23E, despite capex plans of INR20b over FY23-24E.

* Owing to the challenges faced in CY22, the stock declined 17% during the year and is now trading at a reasonable valuation of 24x one-year forward P/E. Hence, we reiterate our BUY rating on GUJGA valuing the stock at 28x Dec’24E EPS to arrive at our TP of INR679.

* Slower-than-expected pick-up in volume or high gas prices adversely impacting both volume as well as margin can pose a key risk to our recommendation.

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