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CLSA has downgraded the rating on Petronet LNG to under performer with 12-month target price of Rs 60.

Tuesday, July 31, 2007

After a 60% appreciation over the last four months, Petronet’s stock fully reflects the value of the LNG volumes that it has long term contracts for (7.5mt) as well as the possibility of extended spot cargoes, a rollover of its recent 1.25mt short term contract with RasGas and continuing trading gains. These additional volumes are not fully certain but we are nevertheless upgrading our earnings estimates by 30- 40% to build these in. We still find risk reward unfavourable, though, unless clarity on long term contracts emerges. This may be a difficult to accomplish given the reducing competitiveness of LNG vis-à-vis domestic gas. Downgrade to U-PF.

Petronet may get additional volumes at Dahej.

Petronet LNG recently signed a short-term 1.25mtpa contract with RasGas to supply the Dabhol power plant. This will essentially replace spot volumes over the next couple of years but it will be looking to rollover this contract when it expires in Sept-09. This will allow it to scale up term volumes at Dahej beyond the 7.5mtpa derived from its long term contracts (base 5mtpa, additional 2.5mtpa) once it expands capacity in phases from Aug-08 onwards. In addition, Petronet is confident of sourcing spot cargoes to fill utilisation gaps that emerge due to delays in signing term contracts for the full 12.5mtpa potential capacity.

Upgrading estimates by 30-70%.

The roll-over of the short-term contract and spot cargoes are uncertain but we are building these in into our estimates given Petronet’s sourcing record in a challenging macro environment. Higher volumes would also imply a cut in re-gas charges by 15-20%, though, (inline with Petronet’s own expectation) when capacity doubles in FY09-10CL. In addition, we estimate that Petronet is also able to accrue USD 0.5/mmbtu of trading gains for its short term volumes which we are building in our FY08-10CL estimates. Aggregating all these, we are upgrading our FY08-10CL estimates by 30-40% and expect earnings to rise at a 20% 3yr cagr.

Outlook on a LNG import model remains uncertain.

Nonetheless, we find several challenges to an LNG import model in India in the years ahead given the changing demand-supply regime. First, LNG will be 40-60% overpriced vis-à-vis domestic gas from 2009 (20-30% more expensive than Reliance’s gas) when Petronet’s long-term import prices starts increasing. Second, the shorter term volumes are uncertain and are priced even higher. Third, contracting long-term volumes at reasonable prices to replace uncertain short-term contracts is difficult given the dichotomy of tight globaldemand- supply and an impending supply surge in relatively cheaper domestic gas.

Downgrading recommendation to U-PF.

Petronet’s 60% appreciation over the last 4-months now fully reflects the base-value of its long term contracts (7.5mt) and also builds in extended spot cargoes, a rollover of its recent 1.25mt short term contract and continuing trading gains, in our view. Near term results will be strong (albeit led by more risky short term contracts and trading gains which will make up 40-45% of profits) but a re-rating will be contingent on clarity on assured contracts that will make LNG competitive in India (sub-USD 5/mmbtu fob). This is difficult to accomplish. U-PF.


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