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Tariff order disappointing; volume outlook remains robust

* On 20th Apr’24, the Petroleum and Natural Gas Regulatory Board (PNGRB) issued a tariff order (TO) for Gujarat State Petronet (GUJS)’s HP gas network. The tariff was reduced to INR18.1/mmBtu from INR34.0/mmBtu (provisional), which was a major disappointment. Following the TO, we cut our FY25/26E EPS estimates for GUJS by ~41% each. We also reduce our TP by 21% to INR355.

* However, we see limited downside for the stock from the current levels, considering the value of GUJS’ stake in Gujarat Gas (GUJGA) itself is ~INR270/ share vs. its CMP of INR305/share. GUJS’ CMP implies a holding company discount of ~38% vs. our assumption of 25%

* While the stock may remain under pressure in the near term, we highlight a favorable spot LNG price environment that bodes well for the utilization outlook of LNG terminals. Recently, the Central Government invoking Section XI to stimulate gasfired power generation is also a positive development. Reiterate BUY with a revised TP of INR355.

Limited downside from current levels despite the disappointing TO

* Based on our estimates, GUJS is likely to generate an ROE of ~6% in FY26. We value its core business at 8x FY26E P/E (EPS adjusted for dividend income). As such, we believe that even in the worst-case scenario, its core business value should not drop below INR50/share.

* We now value its stake in GUJGA and Sabarmati Gas at INR273/share. This valuation is based on GUJGA’s CMP and assumes a 25% holding company discount.

* Overall, we believe there is limited downside to GUJS’ share price from these levels. 

PNGRB’s tariff revision a major disappointment

* On 20th Apr’24, PNGRB issued a tariff order for GUJS’ HP gas network. The tariff was reduced to INR18.1/mmBtu from INR34.0/mmBtu (provisional). GUJS had requested for an upward tariff revision to INR50.77/mmBtu. The key difference between GUJS and the regulator’s view stems from three heads: 1) capex (INR13.7/mmBtu reduction), 2) opex (INR8.7/mmBtu reduction), and 3) volume divisor (INR11/mmBtu reduction).

* The revised tariff will be applicable from 1st May’24. The tariff can be reviewed in the event that actual volume flows (GUJS’ submission: 26mmscmd) vary considerably from PNGRB’s assumption of 32mmscmd. Further, we believe that GUJS may appeal to PNGRB to review its tariff decision, though we do not expect any near-term relief.

We cut our FY25/26E EPS by ~41% each; TP reduced by 21%

* We were building in a tariff decline of ~15% YoY in FY25, while the actual decline in tariff for the HP gas grid stands at ~47% (vs provisional). At this revised tariff, our FY25/26E EPS has been cut by ~41% each. The TP, though, has been reduced by 21%. The core business now accounts for only INR81/share out of our TP of INR355.

* We remain positive on the prospects of gas utilities given: 1) the bleak spot LNG price outlook, which we believe will continue to stimulate demand, and 2) the Central Government’s recent decision to impose Section XI for gas-fired power plants.

* Further, the available LNG capacity in Gujarat is expected to grow to 42.5mmtpa over the next 2-3 years. Most of this volume is likely to flow through GUJS’ network. We believe the company could post a 15% CAGR in transmission volumes over FY23-FY26. We expect GUJS’ volumes to jump to ~38mmscmd in FY26, up from ~30 mmscmd in FY24.

* Further, improved demand owing to the focus on reducing industrial pollution {Gujarat has five geographical areas (GAs) identified as severely/ critically polluted} is a key catalyst.

Valuation and view

* Investments in GUJGA and Sabarmati Gas at a 25% holding company discount provide a valuation of INR273. Valuing the core business at 8x adj. FY26E EPS of INR10.2, and adding the value of investments, we arrive at our TP of INR355. We reiterate our BUY rating on the stock with a potential upside of 17%.

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