Introduction to Petronet LNG: A Strategic Leader in the Indian Energy Sector

As Asia's largest player in the natural gas regasification sector, Petronet LNG has built a strong position in India's energy landscape. The company holds a near-monopoly in the segment, with a total installed capacity of 20 million metric tonnes per annum (mmtpa). This dominates 66.7% of India's total regasification capacity of 30 mmtpa. Being the first mover and having a commanding presence in the sector, Petronet LNG continues to outperform its competitors.

Competitive Advantage: Scale and Cost Efficiency

One of the key factors driving Petronet LNG's success is its ability to scale up at lower costs. The company has already invested in infrastructure and plant expansions, making cost-efficient capacity increases a reality. For instance, it expanded its Dahej plant from 10 mmtpa to 15 mmtpa in FY17 at a relatively low cost. This initial investment has positioned Petronet LNG to handle more than one-third of the total industry capacity by 2020.

Best Position in the Value Chain

Petronet LNG enjoys a sweet spot in the natural gas supply chain. Unlike other players whose pricing is regulated by the PNGRB, Petronet can pass on major price fluctuations to both its customers and suppliers. This strategic advantage allows the company to maintain strong margins and profitability. The ability to adjust pricing according to market dynamics gives Petronet LNG an edge over its competitors.

Secure Market with Growing Demand

India's natural gas market is characterized by a consistent supply-demand gap. While the demand for natural gas was 358 million metric standard cubic meters per day (mmscmd) in FY17, supply was only 157 mmscmd, according to BP Energy Outlook 2017. However, India's natural gas consumption is still underdeveloped, with only 7% of the country's total energy consumption coming from natural gas, compared to 24% globally. This indicates significant growth potential for natural gas in India, driven by its clean and affordable attributes.

Insured Supply Contracts for Future Growth

Petronet LNG sources its natural gas from RasGas Qatar through long-term contracts. Despite initial unfavorable contracts that led to high LNG prices, the company renegotiated better terms by 2015. These new contracts are dynamic and fluctuate based on crude oil pricing, providing the company with more flexibility and risk management. Additionally, the company has secured favorable contracts with suppliers in Australia, further diversifying its supply base.

Potential for Expansion and International Ventures

Petronet LNG is consistently expanding its capacity, with plans for additional projects in the Andaman Islands. The company has funded these expansions primarily through internal accruals and strong free cash flows, ensuring a sustainable growth model without relying on debt. Geographically, Petronet LNG is also exploring international opportunities, such as building an LNG import terminal in Sri Lanka and collaborating with Bangladesh for a plant with a capacity of 7.5 mmtpa.

Efficient Operations and Strong Financials

Efficiency is at the core of Petronet LNG's operations. Despite operating a partially underutilized Kochi plant, the company has maintained healthy free cash flows. Over the past five financial years, Petronet LNG generated free cash flows of Rs 5000 crore after paying off Rs 1200 crore in debt and incurring capital expenditure of Rs 4000 crore. In FY 2017, the company generated a free cash flow of Rs 1200 crore, which is 3.5% of its current market capitalization of Rs 34710 crore. This strong financial performance, coupled with a 26% return on capital, underscores the company's robust financial health.

Evaluation of Investment Potential

From an investment perspective, Petronet LNG offers attractive earnings yields of 17%, making it a compelling option for large-cap investors in the current market. The stock is trading at 10 times earnings, well below its 5-year median level of 12 times. Considering the substantial growth opportunities and steady cash flows, investors can consider holding this stock for the long term.