Merrill Lynch has maintained buy rating on Gujarat State Petronet and expects target price of Rs 65.

Merrill Lynch research report on Guajrat State Petronet

22m shares allotment to IFC at Rs 57.3/share; retain Buy

The board of Gujarat State Petronet (GSPL) has approved issue of 22 million equity shares to International Finance Corporation (IFC) at Rs57.3/share on preferential basis. This is subject to approval of shareholders of GSPL. It would mean 4% equity dilution and bring in Rs1.26bn (USD 30 million). We have kept GSPL’s EPS unchanged despite an estimated 4% potential equity dilution. We retain Buy.

Issue price to IFC 4.8% above price as per SEBI guidelines

The price of shares to be issued on a preferential basis is subject to guidelines of the Indian market regulator SEBI. The issue price as per these guidelines works out to Rs54.67/share. The preferential issue of shares to IFC will however be at Rs 57.29/share, which is at 4.8% premium to price as per SEBI guidelines. This signifies vote of confidence of IFC to GSPL’s strong growth story.

4% equity dilution but EPS kept unchanged

The issue of 22m equity shares would mean 4% equity dilution. However the cash inflow from the issue of shares would mean GSPL would have to borrow less to that extent resulting in lower interest cost. GSPL has also tied Rs3.4bn loan with IFC at relatively low interest rates. To reflect the lower interest cost we have upgraded GSPL’s FY08E-FY10E net profit by 4%. Higher net profit is neutralized by rise in outstanding shares. Our EPS forecast therefore remains unchanged.

Strong volume and earnings growth story on track

Gas supply in India is set to surge from 2008 mainly driven by Reliance Industries (RIL). GSPL is the only listed gas transmission company, which has long term transmission contract tied up with RIL. Gas discoveries made by GSPC (GSPL’s parent) will also boost its volumes. New growth opportunities may also emerge. Thus GSPL’s strong volume and earnings growth story is well on track.

Retain Buy Strong volume and earnings story on track

Gas supply in India is set to surge from 2008 as Reliance Industries (RIL) starts gas production. GSPL is the only listed gas transmission company, which has firm long term gas transmission contract tied up with RIL. Significant gas discoveries made by GSPL’s parent GSPC also is likely to boost its transmission volumes. New growth opportunities are also likely to emerge. Thus GSPL’s strong volume and earnings growth story is well on track. We retain Buy on GSPL

P rice objective basis & risk Gujarat State (GJRSF)

GSPL’s DCF-based price objective works out to Rs65/share. This is calculated by applying weights to DCF under three different scenarios. We have applied 50% probability to DCF based on base case volume and tariff assumptions, 25% probability to DCF assuming lower volumes and 25% probability to DCF assuming lower tariff. WACC applied is 10% based on 12.2% cost of equity, 10% cost of debt, 34% tax rate and debt-equity ratio of 65%. Risks i) regulatory intervention in the form of cut in tariff – based on high ROEs likely over FY10E-12E; and ii) lower than expected transmission volumes. However, this is likely to be mitigated by i) higher than expected capex which may lower the ROEs in the future; and ii) any shortfall in supplies from one source being made up from other sources.