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Right at the dawn – tariff revision to (en)lighten

* Over the last year and a half, as GUJS’s volumes reached 38-39mmscmd in 1HFY20, there have been continuous investor concerns over the more than optimal utilization rate of its High Pressure Pipeline (HPP) grid. With an adjustment in lieu of the new tax regime (of 25.17%), the tariff revision became a much larger concern, resulting in a huge de-rating in GUJS’s standalone value.

* PNGRB has taken up tariff review of GUJS’s HPP grid - link to draft notification (open house was earlier scheduled on 13th Aug’21, but has been postponed, date of which would be announced later) to determine the new tariff from FY22 onwards. This would also adjust it for the new tax regime (16% pre-tax IRR v/s 18.45% in FY19). The company has proposed to undertake a capex plan of INR45.4b over the remaining life of the pipeline (i.e. over the next 10 years till FY32) on the net block of INR53.8b at the end of FY21 (spent over the last 20 years starting FY01).

* This is in line with management’s repeated guidance of increased capex to augment newer LNG terminal capacities on the gird, which would obviate the need for a tariff cut. In our earlier report (Large appetite for growth), we have focused on the volume prospects available to the company.

* Valuing the company at 7x Sep’23E standalone EPS (trough multiple of the last 10 years), we arrive at our TP of INR500/share and reiterate our Buy rating. With the aforementioned awaited clarity over tariff on the horizon, the stock may see a significant re-rating and catch up to its long term average.

Proposed tariff based on future capex plans

* In its draft to PNGRB, GUJS has proposed a future capex of INR45.4b (over FY22- FY32), against the net block of INR53.8b (over FY01-FY21). The company is working on 13 different pipeline projects (as listed in Exhibit 8), which would constitute a total additional length of 753km (or ~33% of the current length of the HPP grid).

* GUJS has proposed a new tariff of INR54.1/MMBtu (on a GCV basis from FY22 onwards). This is considering volumes of 26mmscmd from hereon on the HPP grid (v/s 28.8/32.3mmscmd in FY21/20).

* Although the regulator has sought clarification over the lower volume assumption by the company, considering that volume continues to flow at 100% of the nameplate HPP capacity (of 30.5mmscmd), the proposed tariff would fall to INR46/MMBtu (v/s the current tariff of INR34).

Clarity on volumes transported through compressor services

* As per the provisions of sub regulations 12 (2) of NGPL Authorizations (applicable till 22nd Nov’20), the pipeline line entity is required to share 50% of the proposed incremental tariff revenue in the event of an expansion in capacity by over 10%.

* Basis the same, over utilization of the HPP grid stands at 3%/6% in FY19/FY20 (as explained in Exhibit 7), which allays concerns of a higher tariff cut.

* Furthermore, the pipeline projects proposed as a part of the future capex plan (like Dahej-Bhadbhut: 36km, Anjar-Palanpur: 274km, Jamnagar-Okha: 100km) would redistribute volumes off the HPP grid directly to other cross country pipelines.

Sensitivity to a tariff cut and analysis

* Considering a gradual ramp up in volumes, with new terminal capacity additions in Gujarat, our sensitivity for a 5%/10%/20% tariff cut from current levels of INR34/MMBtu results in an EBITDA CAGR of 15%/13%/8% (on the back of 16% volumes CAGR over the same period).

* Similar sensitivity, assuming a 10% volume CAGR (in line with the management’s guidance), would result in flat EBITDA growth at a 20% tariff cut. A 5%/10% tariff cut would result in an 8%/6% EBITDA CAGR over FY21-24E.

* The aforementioned sensitivity would stand true even in the case of an upward revision in tariffs as well (on our current EBITDA CAGR of ~8% over FY21-24E). More importantly, the clarity in terms of a tariff revision would reduce the speculation/concerns over the same and would guide a clear path ahead for the company, with a possible re-rating in terms of volume surprises.

Valuation and view – reiterate Buy

* Over the last five years, EBITDA grew by ~11% CAGR, in line with the ~10% volume CAGR (to ~37msmcmd in FY20; FY21 saw a decline of 7%/3% in EBITDA/volumes respectively due to COVID). The management expects over 10- 12% volume CAGR over the next 4-5 years (as available LNG regas capacity is expected to jump by 75% to 42mmtpa over the next 2-3 years in Gujarat).

* Our estimates suggest a FCF generation over FY22-24E could be ~INR20.4b, which the management plans to use to fund its capex. With major concerns over the usage of cash already been solved (refer our report GSPC: Declining debt removes concern on GUJS), the final piece of the puzzle would be an announcement of the revised tariff.

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

* The company would turn net cash by the end of FY23E (v/s a net debt of INR6.6b in FY21), despite annual capex plans of INR7b. The stock trades at 16x FY23E EPS and 10x FY23E EV/EBITDA (owing to a huge rally in GUJGA of ~45% in the last two months). We reiterate our Buy rating.

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