GAIL India – 2QFY2011 Result Update: Angel Broking

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GAIL India – 2QFY2011 Result Update

Angel Broking maintains an Accumulate on GAIL India with a Target Price of Rs534

For 2QFY2011, GAIL India (GAIL) reported good performance, registering robust

29.5% yoy growth in the bottom line to `924cr (`713cr), which was marginally

below our estimate of `942cr. On the operational front, the natural gas

transmission and natural gas trading segments delivered good performance on

higher volumes, tariffs and marketing margin on APM gas. We maintain our

Accumulate rating on the stock.

Growth registered across segments: GAIL reported top-line growth of 30.2% yoy

during the quarter, primarily on the back of good yoy performance in the natural

gas transmission, natural gas trading and LPG & liquid hydrocarbon segments.

The natural gas transmission segment registered top-line growth of 26.6%;

operating profit of the segment grew by 19.0% yoy. Gas transmission volumes

grew by 7.8% yoy to 114.9mmscmd (106.6mmscmd) during the quarter. The

LPG & liquid hydrocarbon segment reported 43% yoy growth, driven by higher

realisations and lower-than-anticipated provision towards the subsidy burden.

GAIL’s operating profit during 2QFY2011 grew by 40.9% yoy to `1,433cr

(`1,017cr), below our expectation of `1,524cr due to higher other operating

expenses and higher cost of finished goods purchased. PAT during the quarter

stood at `924cr (`713cr), registering growth of 29.5% yoy, which was 2% lower

than our expectation of `942cr due to lower EBITDA and higher tax rate.

Outlook and valuation: We believe the increasing share of the gas transmission

segment would re-rate GAIL as a utility company. This, along with resilience of the

petrochemical segment to spread compression, reduces earnings volatility.

Hence, we maintain Accumulate on the stock with a Target Price of `534.

Investment arguments

Natural gas transmission segment’s pie to increase: GAIL's plan to double its

pipeline capacity over the next 4–5 years will result in higher share of the

transmission segment in its overall business mix. We expect share of the gas

transmission segment in EBITDA to increase to 56.7% in FY2012E from 41.2% in

FY2009 on the back of a 29.5% CAGR in gas transmission EBITDA over the

period. Thus, increasing share of the transmission segment will result in GAIL

being viewed as a utility company. This coupled with assured RoCE on pipeline

investments reduces risks and provides a re-rating potential for the company.

Hence, we expect GAIL to get further re-rated.

Petrochemical segment resilient to spread compression: Unlike other

petrochemical companies, GAIL’s petrochemical segment is unlikely to be

adversely impacted by compression in petrochemical spreads. GAIL has a

competitive advantage as it uses gas instead of naphtha as raw material to

produce petrochemicals, thus making it a low-cost producer of petrochemicals in

the country. However, petrochemical prices are dependent on crude oil prices, thus

GAIL’s petrochemical margins get a boost even in a flattish petrochemical margin

scenario in the event of increased crude oil prices. Given our subdued outlook on

crude oil prices, we do not foresee any significant compression in GAIL’s

petrochemical margins in such a scenario.

Outlook and valuation

GAIL’s plan to double its pipeline capacity over the next 4–5 years will result in a

higher share of the transmission segment in its overall business mix. The assured

RoCE on pipeline investments reduces risks and provides a re-rating potential.

Hence, we expect GAIL to get further re-rated on improving revenue visibility,

owing to the increasing share of the gas transmission segment in its revenue and

profitability mix. We expect share of the gas transmission segment in EBITDA to

increase to 56.7% in FY2012E from 46.4% in FY2009 on the back of a 29.5%

CAGR in gas transmission EBITDA over the period. Thus, the increasing share of

the transmission segment will result in GAIL being viewed as a utility company.

GAIL has been permitted to charge marketing margin on APM gas and this will aid

margin expansion and better performance by the natural gas trading segment.

GAIL also has significant plans in the city gas distribution (CGD) space.

The company plans to bid aggressively for CGD projects across the country

through its wholly owned subsidiary, GAIL Gas. We believe the CGD business

could be a value-accretive proposition in the long run.

We have valued GAIL on an SOTP basis with a revised Target Price of `534/share

(core business valued at `486/share, E&P at `20/share and cash and investments

at `28/share). At the CMP of `495, the stock is available at 14.9x FY2012E EPS of

`33.3 and 2.8x FY2012E P/BV. We maintain an Accumulate on the stock with a

Target Price of `534.