Gujarat Pipavav IPO- AVOID

KEY POINTS

Gujarat Pipavav port is the developer and operator of APM Terminals Pipavav with exclusive right to develop the port and related facilities till September 2028. The company is promoted by APM Terminals, one of the largest terminal operators In the world with a global network of 49 terminals in 32 countries. The port is capable of handling 0.6million TEU’s of container cargo and ~5million tonnes of bulk cargo every year.

The port is an all weather port with four berths for handling bulk and containerized cargo and one berth for handling LPG cargo. The 4550m channel length allows day and night marine operations at the port.

OBJECTS OF THE ISSUE

The key objects of the issue are repayment of debt, additional capital expenditure to improve and enhance infrastructure and other regular recurring capital expenditure.

COMPANY OUTLOOK

Pipavav port is located near the entrance of Gulf of Khambhat on the main maritime routes which has helped the company serve the north and north western hinterland. The company has witnessed a revenue CAGR of 16%, EBITDA CAGR of 15% over CY06-09. The margins have improved from 19% in CY2006 to 22% in CY2009. The growth witnessed in the EBITDA however, has not been able to reflect in the PAT. The company has been continuously reporting losses since CY2003. The primary reason being the heavy interest and depreciation expenses witnessing a CAGR 35% and 24% respectively over CY06-09. The company as of CY2009, had a D/E of 3.5 and interest coverage of 0.03.

The EBITDA margins of the company are way lower compared to that earned by Mundra Port. The primary reasons being

1. The company has been paying penalty charges as per the Traffic Guarantee Agreement, because it has not been able to generate the minimum guaranteed rail freight traffic volumes of 3mt. As of 2009, the port handled 0.2mn TEU of container cargo = 4MMT. Out of this the rail freight was only 35% i.e. 1.4MMT, a shortfall of 1.6MMT from the target of 3MMT.
2. The company relocated its LNG cargo jetty, so it had to pay Rs. 2.76million per month as damage charges to Shell.

In order to judge the attractiveness of the issue we do a best case analysis for the company wit the following assumptions

1. The company achieves a critical volume of 3MMT in container cargo thereby avoiding payments for not achieving the minimum guaranteed freight volume


2. The LNG jetty is operational and the company does not pay the monthly damage charges to Shell


3. Interest rate on debt at 11% per annum.


4. EBITDA margins of 37% assuming no penalty payments to railways for lower cargos and to Shell for LNG.

From the above table it can be seen that after repayment of debt from the proceeds of the issue, the breakeven for the company comes when it achieves a capacity utilization of 70% in bulk cargo and 83% in container cargo, i.e. have bulk cargo volumes of 3.52MMT as compared to volumes of 2MMT in FY08 and volumes of 0.5MTEU as compared to 0.2MTEU handled in FY08. We believe, this growth cannot happen in a year or two and moreover Mundra is the preferred port for most shipping lines due to its higher draft and ability to handle bigger ships providing stiff competition to Pipavav.

Since the company has been making losses at a PAT level, comparing the PE ratios is not an option, we believe the EV/EBITDA and the P/B ratios to be more meaningful indicators. Since the company is using the proceeds to pay back the debt, we believe EV/EBITDA to be a more meaningful indicator than P/B. This is so because the fresh issue will increase the book value thereby pulling the P/B down. On a EV/EBITDA basis, Pipavav trades at a huge premium to Mundra port.

Given Mundra port scale of operations, expansion plans and its operations in SEZ area we believe it provides a stable and better upside as compared to Gujarat Pipavav which earns lower margins and is valued on the higher side as compared to Mundra port on EV/EBITDA. Also, as we have explained in our best case scenario even after using the proceeds to repay the debt, Gujarat Pipavav will have to its cargo handling substantially both in Bulk segment as well container cargo just to break even. Given the greater draft, better turnaround times and better connectivity to northern hinterland from Mundra, we believe this ramp up will be slow and not very sudden and fast.

WE RECOMMEND THAT INVESTORS AVOID SUBSCRIBING TO THE IPO.If investors want to take exposure to port segment they should look at investing in Mundra port rather than the investing in Pipavav which in our opinion is expensive and a risky bet

Valuation ratios for Pipavav at upper and lower price bands

Comparison with Mundra Port on key valuation parameters

^Calculated at share price of Rs. 815
^^Calculated at upper price band of Rs. 48
#Figures as of FY10
##Figures as of CY09

GAIL Q1FY11 Result Review

GAIL reported its Q1FY11 results. The following is a snapshot of the results

• The company reported revenues of Rs. 7116cr (Up 17.8% Y-o-Y and 8.3% Q-o-Q), EBITDA came at Rs. 1455cr (up 34% Y-o-Y and 6.7% Q-o-Q). The margins came at 20.4% up 2.4ppt from 18% in Q1FY10. The PAT came at Rs. 887cr(Up 35.2% Y-o-Y, down 2.6% Q-o-Q)

Transmission Business

• The natural gas transmission revenues increased to Rs. 896cr from Rs. 733cr (increase of 22% Y-o-Y). The increase was a result of greater volumes and better realizations.
• The volumes increased from 96.68mmscmd to 116mmscmd (Up 20% YoY, up 1% Q-o-Q), as the company had made operational 2 pipelines during the previous Financial year namely Vijapur-Dadri and Chainsa-jhajhar pipeline and Dadri-Babana pipeline.
• The transmission charges increased 1.8% YoY to Rs. 846/tscm as compared to Rs. 831/tscm in Q1FY10
• The LPG transmission revenues came at Rs. 114cr (Up 7.4% Y-o-Y and down 7.2% Q-o-Q). The revenue growth was led by
• Volume growth of 6.3% Y-o-Y to 788TMT from 741TMT
• Realization increase of 1.9% Y-o-Y to Rs. 1441/MT as compared to Rs. 1426/MT in Q1FY10. The company takes an annual increase of 2% on the LPG transmission services

Gas Trading

• The Natural gas trading revenues came at Rs. 5452cr (Up 17.5% Y-o-Y, up 16.8% Q-o-Q). The volumes of natural gas traded have remained largely stagnant as the KG Basin gas is being directly placed by Reliance and the company does not trade the gas. The revenue increase was led by
• 6.16% Increase in volumes to 84.86mmscmd from 79.93mmscmd
• 10.64% increase in realizations to Rs. 7040/tscm as compared to Rs. 6363/tscm. The increase is a result of the fact that GAIL has now been allowed to charge marketing margin on the APM Gas it trades and also the APM gas prices were hiked, the full effect of which would only be visible in Q2FY11. The prices of APM gas has been hiked from from Rs 3200/tscm to Rs. 7500/tscm.

Petchem, LPG and liquid Hydrocarbons

• Petchem segment reported revenues of Rs. 637cr (Up 3.6% Y-o-Y) on account of strong realizations which came at Rs. 72/kg as compared to Rs. 68/kg in Q1Fy10 despite sales volume declining to 88TMT from 92TMT
• The LPG segment reported a volume growth of 6.2% Y-o-Y and the other liquid hydrocarbon witnessed a volume growth of 7.9% Y-o-Y. The combined realization for the segment came at Rs. 21951/MT as compared to Rs. 20476/MT (Up 7.2%). The combination of the two factors led to revenues from the liquid and other hydrocarbon segment increasing by 14.2% Y-o-Y. Since GAIL reports the subsidy in this segment, it means the hydrocarbon realization would have witnessed a good growth, as the subsidy payout has increased

Other Line Items

• The EBITDA margins came in at 20.4% in Q1Fy11 as compared to 18% in Q1FY10. The increase in EBITDA is a result of good performance from the LPG and other liquid hydrocarbon segment coupled with the fact that other expenditures declined to 451cr from 485cr as the company booked only Rs. 20cr as dry well expenditures in Q1Fy11 as compared to Rs. 118cr booked in Q1FY10
• The company shared subsidy to the tune of Rs. 445cr as against 74cr in Q1Fy10

Our Expectations

In our view, the core business which according to us includes the Gas and LPG Transmission and Gas Trading is not much dependent on the external factors apart from policy decisions. The Gas and LPG transmission revenues are governed by PNGRB guidelines on how much returns can be made on pipelines and only way of accelerating the revenues from this segment is capacity expansion or favourable changes in calculation of transmission tariffs. The gas trading business is a volume and marketing margin play. With the government allowing GAIL to charge marketing margin on all the gas it transports now, this segment is also expected to benefit. We believe the monopoly of GAIL in terms of pipeline network gives it a stable revenue source from these three segments. The GAIL pipelines once in place would cover all the demand centers and hence the volume offtake will happen through its pipelines.

The only moving part in the entire GAIL story is the subsidy shared by the company and the dependence of its petchem and liquid hydrocarbons realizations on market demand and supply for these products. These are expected to have stable (by stable i mean not absolutely flat but i would say less volatility) performance going forward.

We arrive at a fair value of 473 for the stock and recommend long term investment in the stock.

Petronet LNG Q1FY11 Result Update

Petronet LNG reported its Q1Fy11 results and following is a snapshot of the results.

Business Model

The company operates in the field of LNG regassification. The company buys gas from Qatar which has huge facilities to convert Natural gas into Liquefied natural gas by compressing it to 1/600th of the original volume. Petronet has regassification facilities at Dahej wherein it converts the LNG received in ships to Natural gas and it charges a regassification charge for the service it provides. The company deals in three kinds of volumes (a)Contracted volumes (Long term) (b) Spot cargoes (c)Regassification/Tolling volumes. In the first case the company earns the specified margins which is increased 5% every year, and since these margins are out of the purview of PNGRB the company has been taking these increase every year without any regulatory intervention. In the spot cargo apart from the regassification charges the company also earns a certain marketing margin on the gas as it takes the risk and the administrative tasks of placing the gas with the end consumer which in the first case is borne by the off-takers like GAIL, IOCL. In the third case, the company does not buy the gas but only offers the services to an external party. The % margins is not a good way to look at this company because the topline is a function of the natural gas prices and the margins vary hugely depending on the composition of spot volumes, contracted volumes, and the pricing of the spot volumes. Therefore the concept of netback (Revenues/unit - raw material cost per unit) is generally considered a better measure for these companies (This concept is similar to the GRM - Gross refining margin concept in case of oil companies).

Result Review

1. The results were ahead of our estimates on all counts i.e. revenues, ebitda and profit. The major surprise for came at the EBITDA level. The company in the quarter was expected to reply largely on the contracted volumes and the spot volumes were expected to be minimum. The difference between the spot and the contracted volumes being, the contracted volumes have gaurnteed offtake agreements with GAIL, IOCL and BPCL while the spot volumes are on customer requirements. For spot volumes to happen the pipeline capacity should be available to the company. Given the increase in KG basin volumes, the HVJ pipeline capacity was fully utilized and there was little spot volumes that could offtake. This was the premise on which our volume assumptions were based.
2. On the margin front, we had assumed an netback margin (Sales price - cost of raw materail) at Rs25/mmbtu as the company takes a 5% increase each year on its regassification charges.
3. The results however better than what we had anticipated, the company was able to do some spot volumes in the quarter and the netback came in much better Rs. 30.7/mmbtu.
4. The company reported revenues of Rs. 2508cr (down 3.7% Y-o-Y and up 5.4% Q-o-Q), EBITDA came at Rs. 248cr (up 36.3% Y-o-Y and 22.5% Q-o-Q), PAT came at Rs. 111cr (up 7.8% Y-o-Y and 14.5% Q-o-Q)
5. The Y-o-Y decrease in revenues is a result of the following factors
• The sales volumes declined by 7% Y-o-Y to 89.46TBTU as compared to 95.84TBTU in Q1FY10
• The realization increased per mmbtu increased from $5.58/mmbtu to $5.98/mmbtu an increase of 7%
• The rupee appreciated by 3.6% in the following period from 48.4 per dollar to 46.92 per dollar.
6. The netback margins on the sales volume stood at Rs. 30.7/mmbtu up 45% Y-o-Y from 21/mmbtu on account of the 5% hike being taken by the company in regassification margins each year and secondly due to better cost controls and internal usage of gas which has declined due to measures put in place by the company. The netback margins on the regassification services offered by the company stood at Rs. 31.7/mmbtu as compared to 28.5/mmbtu in Q1FY10.
7. Despite a 36.3% increase at the EBITDA level, the same could not come down at the PAT level because of the depreciation expenses which increased 80%. The nature of the business being a high fixed cost business, any incremental volumes help the company at the PAT level. In Q1FY10 out of 95.8TBTU handled 33.1TBTU were from spot cargo and the total utilization level stood at ~100%. But in the current quarter spot volumes were very minimal and the capacity utilization stood at 74%(capacity was enhaced in Q2FY10).

Our Expectation

The spot volumes should revive going forward as the pipeline capacity becomes available to the company for transporting the spot cargo. Moreover the Kochi expansion that the company is undertaking is on schedule and should be done by the last quarter of FY2012. Given the demand supply mismatch and the KG basin ramp up not happening, the demand for spot LNG is likely to go up. At the current levels we recommend a BUY on the stock with a one year target price range of Rs. 92-106.