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GSPC: Declining debt removes concern on GUJS

* Gujarat State Petroleum (GUJS) has a 54% stake in Gujarat Gas (GUJGA), which amounts to a market capitalization of INR197b, much higher than GUJS’ m-cap at INR156b.

* Major concerns for the above anomaly have been: a) expected decline in tariffs of GUJS due to over-utilization of the High Pressure grid, and b) concerns over the usage of cash.

* Gujarat State Petroleum Corporation (GSPC), the parent company of GUJS with a 37.6% stake, has traditionally been a debt ridden company, raising concerns whether the cash generated by GUJS may be used to reward minority shareholders.

* In our earlier report (Large appetite for growth), we have addressed the first concern on tariff. This note busts the second myth.

* At a 25% holding company discount, the 54% stake in GUJGA provides a valuation of INR275/share to GUJS. We value GUJS’ standalone operations at 7x to arrive at our TP of INR400/share (core business continues to trade for free) and reiterate Buy.

Sharp reduction in net debt

* GSPC’s tryst with upstream investments has not been successful, resulting in its standalone/consolidated net debt rising to a peak of INR234b/INR277b in FY17.

* It sold off its stake in the KG basin in FY17 to ONGC and wrote off INR149b. It also consolidated its stake in GUJGA with GUJS in FY18.

* As a result of better profitability from subsidiaries/JVs and lack of continued capex in upstream, consolidated net debt has reduced from a peak of INR262b in FY17 to INR76b in FY20

Rationalizing upstream assets

* The company recorded cumulative impairment losses of ~INR162b over the past five years, with the biggest loss coming in from the KG basin in FY17.

* GSPC has also written-off exploration costs of ~INR36bn over the past decade.

* The management classified 12 E&P fields as assets held for sale in FY19 and had provided for an impairment loss of ~INR1.5b. Total cumulative investments since FY05 is INR232b, of which after write-off, left over assets stand at INR22b and liability at INR7b - not leaving much to be written off even in the worst case.

Improving financials bust the second myth

* Post write-offs, the company earned a consol. PAT of INR16b/INR23b in FY19/FY20. The same for the standalone entity remains poor at INR3b/INR4b.

* FCF stood at INR35b/INR40b in FY19/FY20 led by better profitability of GUJS and GUJGA. Consol./standalone net debt has also declined to 1.7/1.3x in FY20.

* GSPC Mundra was commissioned in Feb’20 and its ramp up would also contribute to better profitability of the group. The remaining subsidiaries are smaller and would not require much capex going forward. Hence, debt-to-equity is expected to improve going forward, laying to rest concerns that investors may have on the improper use of GUJS’ cash.

Valuation and recommendation

* GUJS has a debt of INR11.4b at present. The management targets to become debt free in the next 3-4 quarters. It could reward shareholders by increasing its dividend payout from ~12-13% at present (the company has an interest cost of ~INR1b – similar to dividend payments).

* Over the last five years, EBITDA grew by ~11% CAGR, in line with the ~10% volume CAGR (to ~38msmcmd in FY20), despite average implied tariff of ~INR1,215, lower than ~INR1,240 in 3QFY21. The company has been guiding volumes CAGR of over 10% for the next 5 years. Available LNG regas capacity is expected to jump 55% to 42.5mmtpa (from currently ~27.5mmtpa) over the next 3-4 years in Gujarat.

* Our estimates suggest overall FCF generation over FY21-23E could be ~INR21.3b. The company plans to use the excess cash flow to fund capex of INR24b (via internal accruals) over the same period.

* Total capex guidance stands at INR40b over next five years against net fixed assets (NFA) of INR43b for the HP pipeline when its tariff was decided in CY18. The management remains confident that higher utilization is unlikely to result in a cut in tariffs (note that we are not building in any impact to our model.

* Strict action against usage of industrial pollution would further increase the demand of gas and may result in much higher transmission volume than that considered. On the risk side, non-approval of capex proposed by GUJS, resulting in a sharp cut in tariff, remains the biggest risk.

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