[T.S.R:16133] GSPL-Kotak Sec Goes Contrarian With A Reduce Rating & Tgt of Rs 95

GSPL reported 2QFY10 net income at Rs1.1 bn (+37% yoy and +289% qoq) led by (1) higher gas transmission charges of Rs0.89/cu m compared to Rs0.83/cu m in 2QFY09 and Rs0.91/cu m in 1QFY10, (2) reversal of Rs37.7 mn in employee costs towards salary arrears and (3) higher other income.  GSPL's volumes were at 2.86 bcm (31 mcm/d) lower than our expectation of 32 mcm/d. We are not sure about the sustainability of GSPL's current tariffs since it may be curtailed by the new regulations for long-distance gas transportation pipelines. We find the current tariff too high since it translates into an estimated pre-tax ROCE of 30% based on 1HFY10 data versus 18.2% allowed as per new regulations effective November 2008. Valuations are a function of tariffs; assume a certain input and get a desired output We find it difficult to value GSPL stock since we do not know what tariffs to assume for it in the medium term. GSPL's current tariffs reflect its monopoly status as can be seen from its pre-tax ROCE of 30%. We note that its returns will increase further as volumes increase over the next few years without a commensurate increase in capex.  Our 12-month DCF-based target price of Rs95 is based on tariff assumptions, which result in very high CROCI for 20.7% in FY2010-20E. If we assume 2QFY10 tariff of Rs0.89/cu m in perpetuity, we get a 12-month forward DCF valuation of Rs181 and average CROCI of 32.7% in FY2010-20E. However, the same drops to Rs53 with average CROCI of 15% in FY2010-20E based on a constant tariff of Rs0.4/cu m in perpetuity.  We believe the last scenario may be more reflective of reality. The new regulations permit 12% posttax or 18.18% pre-tax return on capital employed. Estimating earnings remains a hypothetical exercise pending implementation of new regulations We have revised FY2010E, FY2011E and FY2012E EPS to Rs6.4, Rs11.8 and Rs12.9 from Rs5, Rs9.6 and Rs12.1 to reflect (1) higher gas transmission tariffs and (2) 2QFY10 results. We model gas transmission volumes for FY2010E, FY2011E and FY2012E at 31.2 mcm/d, 50.6 mcm/d and 61.6 mcm/d, respectively, versus 14.9 mcm/d in FY2009 and 28.2 mcm/d in 1HFY10. Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.   Nothing in this article is, or should be construed as, investment advice.

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