GAIL India- Expect strong 4Q operational profit growth :: Macquarie Research,

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GAIL India
Expect strong 4Q operational profit growth
Event
 We expect GAIL to post a strong 18% QoQ increase in 4QFY11E earnings
from operations. Volume growth and margin expansion shall drive both gas
transmission and petrochemical division earnings. However, it’s reported
profits may be flat as past dues may double its oil subsidy burden. We
maintain OP with TP of Rs573, and reiterate GAIL as one of our top picks

Impact
 Operational profits estimated to rise 30% YoY, 18% QoQ: We expect
GAIL’s 4QFY11 operational earnings (ex-subsidy impact) to show strong
growth on the back of margin expansion in converter businesses (petrochem
and liquid hydrocarbon production), and expansion of its cracker at Pata.
 Transmission volumes to inch up despite KGD6 decline: GAIL has borne
the brunt of KGD6 production issues, but we believe that markets are building
in a decline in transmission volumes and have overpenalized the stock. Based
on management conversations, its gas transmission volume shall rise ~3%
QoQ, as increased LNG imports could more than offset fall in KGD6 volumes.
 Volume growth and margin expansion to boost petrochemical earnings:
The Pata gas cracker had an expansion-cum-maintenance shutdown for 23
days in 3QFY11. Also, inventory build-up of ~20% of capacity (see Fig 4)
resulted, due to low sales. We believe that petchem segment could witness
strong growth from the sell-off of inventory & increased operational capacity
(~10%) kicking in from this quarter, coupled with 4.5% QoQ margin expansion
(see Fig 3) due to product prices being pulled up by the rallying crude prices.
 LPG netback margin expansion of 27% YoY: The recent sharp rally in
crude prices has boosted LPG prices in excess of a 10% hike in price of input,
gas since Dec 2011. We expect GAIL’s netback margins to be marginally
down QoQ, but to expand ~30% YoY as a result.
 A potential doubling of subsidy constrains bottom line: We expect the
burgeoning under-recovery due to non-revision of retail fuel prices to double
GAIL’s subsidy burden QoQ to Rs8.2bn (8% share of upstream, which shares
~33% of total), and hence drag reported earnings to a QoQ flat trajectory.
Earnings and target price revision
 No impact.
Price catalyst
 12-month price target: Rs573.00 based on a Sum of Parts methodology.
 Catalyst: Completion of Dahej-Vijaipur-Dadri pipeline capacity expansion – 11
mmscmd already done, 43–50 mmscmd to be added, possibly by June 2011.
Action and recommendation
 GAIL dominates India's 3-player gas transmission oligopoly benefiting from a
doubling in volumes and tariffs. Its profit growth should exceed 20% pa, and
yet it quotes just 13x PER. We believe a 10% QoQ stock price relative
underperformance provides a buying opportunity.