GAIL (India): Sell :: Business Line

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Despite the 8 per cent fall last week, the stock of gas transmitter GAIL (India) is up 43 per cent over the last year. The rally has been driven primarily by prospects of a lower subsidy burden due to the gradual rise in diesel prices and their eventual decontrol. GAIL has been bearing about 1.5 per cent of the under-recoveries incurred by Indian Oil, HPCL and BPCL from selling diesel, LPG and kerosene below cost.

Diesel, the largest contributor to the under-recoveries, is now out of the subsidy purview. In previous years, the quantum of subsidy borne by GAIL has been 40-50 per cent of its annual profit. So, the benefit from subsidy reduction could be big.

Still, investors can sell the GAIL stock. Its sharp run-up seems to be factoring in the positives in good measure while ignoring the negatives the company faces. At ₹485, the stock trades at 13.5 times its trailing 12-month earnings, higher than the average levels it traded at in the past three years (10.5 times). Importantly, GAIL’s core business prospects do not seem bright, at least for the next two to three years.

Declining volumes

The major contributor to the company’s profit — the gas transmission business — has been under pressure for quite some time due to declining domestic gas production and capacity constraints impeding growth in imported gas volumes.

From 119 mmscmd in the September 2011 quarter, GAIL’s gas transmission volume fell to 95 mmscmd in the September 2013 quarter and further to 91 mmscmd in the recent September quarter. With volumes declining, GAIL’s extensive gas pipeline network in the country remains largely underutilised, even as the company incurs depreciation and interest costs. In South India, projects are stuck due to disputes with farmers and the Tamil Nadu Government over laying gas pipelines through farmlands.

The situation may not improve any time soon. The recent hike in domestic gas price to $5.61/mmbtu from $4.2 is below expectations and is not likely to enthuse domestic gas producers to step up output. Imported gas volumes may also not rise significantly in the medium term. Gas importer Petronet’s terminal at Dahej in Gujarat is currently operating at full capacity, and expansion is two-three years away; its Kochi terminal is significantly under-utilised due to lack of pipeline connectivity.

GAIL’s dispute with the Tamil Nadu Government is now in the Supreme Court; the case could drag on and the outcome is uncertain. It does not help that higher domestic gas price and increased dependence on costlier imported gas will impact the profitability of GAIL’s petrochemicals business.

In 2013-14, the company’s profit rose about 9 per cent, but this was thanks to the lower subsidy burden and not better core performance. Again, after a dismal showing in the June quarter, the 42 per cent profit growth in the recent September quarter was mainly due to nil subsidies — operating performance deteriorated across most segments. Quarterly subsidy numbers are to be taken with a pinch of salt; the final adjustment usually happens in March. Also, the positive rub-off from lower subsidies will play itself out over a few quarters. What will matter then is core growth — on this front, GAIL faces an uphill task.