Petronet LNG: Expanding gross block by leaps - Outside View by Luke Verghese

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Petronet LNG: Expanding gross block by leaps
Sep 8, 2010

Frugality to the fore

If one is looking for a classic example of corporate frugality, look no further than Petronet LNG. For a company which recorded a gross turnover of Rs 107 bn, and a pre-tax profit of Rs 6 bn in FY10, it has taken parsimony to another level. The wafer thin annual report, printed on 'raddi' paper, runs into all of 40 pages. The fact that the company has 476,000 shareholders to service could be one reason though. And, the directors' report is couched in such fine print that one has to use a magnifying glass to read the contents of the report.

A 'cushy' life really

In a manner of speaking, the company has a cushy life really, with just about everything set out on a platter for it. And, being primarily a government owned company it gets what it wants. It principal promoters are the 4 PSU oil biggies, ONGC, IOCL, GAIL and BPCL, who with individual stakes of 12.5% each, collectively hold 50% of the outstanding equity. A French company GDF International, which is one of the world's largest dealers in LNG gas, holds another 10% of the equity. The Asian Development Bank too has chipped in a little over 5%. The balance 35% odd has been parceled out to the public.

The business

Petronet is India's first, and by far the largest dealer in liquefied natural gas (LNG). It was not that many moons ago that LNG was found as a resource base available on Indian shores. This new development is thanks to gas discoveries in the Krishna-Godavari basin, for a start. But the 12 years young Petronet LNG predates this discovery. What the company does presently is to import raw LNG on long term contracts from RasGas, Qatar, through dedicated ships, to Dahej in Gujarat. (Qatar is the world's largest exporter of LNG). It then re-gasifies the gas, and then sells the commercially viable gas. But the sales are not necessarily affected to the end user. As a matter of fact the vast bulk of its sales are to 3 of its principal shareholders. In FY10 it collectively sold almost 90% of all gas sales or Rs 927 bn (99% or Rs 837 bn in the preceding year) to IOCL, BPCL, and GAIL. More than 50% of this dedicated sale was made to GAIL. The balance sales were apparently channelized to other end users in Gujarat and Maharashtra through cryogenic road tankers. As I stated earlier this makes its life real cushy.

The ways and means of the company

Why it chooses this route to effect sales is not known? But at least it saves quite some money on employee costs by this route. The total payout to employees was a miniscule Rs 204 m for the year. The point is also that LNG is an alternative raw material to coal and oil for the generation of power, especially in the context of soaring prices of crude oil and coal. LNG is also an alternate fuel to end user industries like the fertilizer industry. None of the three principal buyers apparently have any end use for the product, given its raw material character.

Petronet gets its supplies on long term contracts and on fixed prices. It in turn also supplies the end product to its customers based on similar such agreements. The markup that it negotiates between the purchase and sale price is then the focal point. However its power to negotiate, given its charter, appears to be very suspect. Such arrangements however have their own positive and negative fallouts. The good news here is that though it has to pay cash down for what it buys, in turn it gets cash down for what it sells, and, it also gets to sell all that it purchases. Trade receivables at year end for its dedicated sales were a mere 5.5% of such sales. This is probably the principal advantage that it has for selling its end product to its own promoter shareholders. The latter in turn, are probably left to shoulder the burden of collecting dues from their customers for sales that they in turn make! This is the positive fallout.

Reasons for the fall in profitability

The directors' report says that the decline in pretax profit for the year to Rs 6 bn from Rs 7.7 bn in the preceding year, and that to, on a 26% hike in gross sales, was principally due to higher interest and depreciation charges. The writer of the report was apparently tutored on what to write, or was fast asleep when he wrote the copy. For sure the depreciation and interest charges were appreciably higher. But these costs increases were mere pinpricks in the overall scheme of things. The decline in margins was principally due to a lower markup between what it paid for the gas that it bought, and the price that it extracted for what it sold. That is to say, the cost of raw materials debited to P&L account, as a percentage of sales, was higher at 91.1 % against 87.5% in the preceding year. Given the humungous value of the products sold, that is a huge difference. In a sense it appears to have been royally 'rogered' by its own fat cat shareholders. The primary efficiency factor of its operations is measured by this elementary yardstick-period! And, this then, is the negative fallout.

Expansion schemes

But, nevertheless, the company is embarking on several expansion schemes, besides the recent doubling of storage capacity to 10 MMTPA (million metric tonnes per annum). It funded this big capacity expansion in royal style, alright. It generated superior cash flow from operations of Rs 10.2 bn (Rs 2.8 bn in the preceding year) simply by resorting to deft management of working capital funds flow - proving yet again that when a monopoly 'of sorts' really wants to, it can deliver a superior punch. This cash flow generation was about just enough to fund the addition to gross block.

The new expansion schemes include an LNG terminal at Kochi and a second standby jetty at Dahej. The latter scheme will also lead to an increase in storage capacity to 12.5 MMTPA. It has a 26% equity stake in a dry port in the making at Dahej, which will import/export high volume dry cargo. It also proposes to set up a gas based power plant at Dahej. The power plant when operational should give it some power on the pricing front, even though the commissioning of the project is still many moons away.

The funding aspect

The management is thinking quite some bit ahead on the financing front, alright. At year end it had a debt of Rs 28 bn on its books. The resolution to be passed at the AGM calls for borrowing powers to be increased from a already high Rs 100 bn to a whopping Rs 150 bn. Strangely enough, the resolution does not talk about hiking the equity capital base suitably, if the grass roots implementation of the resolution on the debt front is to see the light of day.

The how of the business

Petronet is also a highly capital intensive undertaking given its business module. The basic port, and the facilities to house and re-gas the LNG, and the dedicated ships required to move the cargo, add up to a pretty sum alright. The gross block at year end was a humungous Rs 35 bn, up from Rs 20 bn in the preceding year. Then there is capital work in progress of Rs 13 bn and future contracts to the tune of Rs 20 bn, which is yet to go under the hammer. In other words the gross block will escalate to some Rs 70 bn in short order. (Not included here is the capex on the power plant, in the anvil). What revenues this asset expansion will generate is the moot question. And the markups that it can negotiate are an equally important point worth pondering. Suffice to say that the management is more than up to the task on hand.

In sum total the company appears all set for an exciting future if all the plans fructify. Disclosure: Please note that I am a shareholder of this company

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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