GAIL (India): BUY :: Business Line

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Gas transmission major GAIL (India) has been an underperformer on the bourses for quite some time now. Over the last year, the stock has been down 9 per cent compared with the 7 per cent rise in the Sensex.

The fall in transmission volumes due to decline in domestic gas production has been weighing on the GAIL stock. But this provides a good buying opportunity for investors with a long-term perspective and high-risk appetite.

One, current valuations are attractive. At its price of Rs 341, the stock discounts its trailing 12-month earnings by around 11 times, cheaper than levels in the past (around 15 times).

VOLUME GROWTH EXPECTED

Two, volumes should pick up in the medium-to-long term, with an increase in the supply of imported liquefied natural gas (LNG) making up for domestic gas shortage.

Capacity is being significantly increased at existing LNG terminals at Dahej and Hazira, and new terminals have started operations (Dabhol) or will soon do so (Kochi).

Also, there is a good possibility of domestic gas output picking pace over the next few years.

Especially if the recommendations of the Rangarajan Committee, which will result in higher gas price, are accepted. Due to its cost advantages over alternative fuels, demand for natural gas in the country runs far ahead of supply. Even if prices are increased, the demand for gas should remain healthy.

GAIL which is expanding its pipeline network in the country, including in new markets such as South India, should benefit.

In this context, the recent commissioning of the GAIL-operated Dabhol terminal on the West Coast and the Dabhol-Bangalore pipeline bode well. The company is also in the process of almost doubling the capacity of its petrochemicals business. These measures should aid volumes.

GAIL is also collaborating with international energy companies to secure its gas supplies. It has tied up with US-based Cheniere Energy to source 3.5 million tonnes of LNG for 20 years commencing 2017.

It has also invested in shale gas assets in the US. Recently, the company placed a joint bid with EDF of France for the LNG assets of Spanish hydrocarbon major Repsol in Trinidad and Tobago.

But there are risks. In the near term, the company’s volume growth may remain muted or even decline with the continuing fall in domestic gas production from the KG-D6 fields of Reliance Industries.

Volumes from the expanded and new LNG terminals will increase only gradually, with capacity utilisation likely to be low in the initial years. Also, there have been delays in laying some new pipelines such as the Kochi-Mangalore stretch due to land acquisition issues.

Meanwhile, depreciation and interest expenses on the network expansion will continue eating into profits.

Also, while higher gas prices will benefit volumes in GAIL’s transmission and trading business, it could dent margins in the LPG and petrochemicals businesses.

Besides, the risk of unfavourable action by the downstream regulator PNGRB on transmission tariffs remains. So, an investment at this juncture may be suitable only for those willing to wait.

SUBSIDY UNCERTAINTY

The recent reforms in fuel pricing initiated by the government, if continued, will benefit GAIL by restricting its subsidy burden. In the first nine months of this fiscal, the company’s subsidy burden increased around 18 per cent to Rs 2,100 crore.

On a positive note, the recent December quarter saw a reversal of excess subsidy provided in the September quarter.

If this indicates government intent to cap the company’s burden, it bodes well for GAIL. But it may be premature to take a call on the subsidy-sharing mechanism, which typically is decided in the last quarter of the fiscal.

With the Finance Ministry keen to rein in the fiscal deficit, there is a risk of higher subsidy burden devolving on upstream companies and GAIL.

Also, with general elections early next year, it remains to be seen whether the Government will carry through the fuel price reforms process.

FINANCIAL PERFORMANCE

Despite pressure on volumes and subsidy burden, GAIL has managed to grow sales and profits.

In FY-12, the company’s consolidated profit grew 10.5 per cent to Rs 4,444 crore, and for the recent nine-month period ended December 2012, the company’s profit rose around 7 per cent to Rs 3,404 crore.

Also, despite spending heavily on network expansion, the company’s debt-to-equity as on September 2012 remained reasonable at 0.28 times.