GAIL (India) Ltd (Q4 FY12) – BUY

CMP Rs322, Target Rs366, Upside 13.9% 

• Net sales rise 17.7% yoy on the back of higher realizations for petrochemicals and natural gas sales
  
• One time retrospective cut in tariffs for Mumbai and Agartala network impacts transmission business profitability
  
• OPM slumps 713bps yoy to 7.3% on back of the one time provisions for the tariff cuts which was reflected in sharp fall in EBIT margins for natural gas and LPG transmission segments
  
• Higher subsidy burden on account of under provisioning in Q3 FY12 impacted profitability for the LPG segment
  
• Maintain our BUY rating with revised 9-month target price of Rs366

Higher realizations for the natural gas trading segment results in strong topline growth

Gail (India) Ltd reported net sales of Rs105bn, an increase of 17.7% yoy. Sales were lower than our expectations. Growth in the topline was driven by 27.5% yoy jump in revenues of natural gas trading business. All other segments witnessed decline in revenues. For natural gas transmission, volumes were lower by 4% on the back of decline in KG-D6 production and realizations also fell owing to lowering of tariffs for Mumbai and Agartala networks (Rs2.5bn). For LPG transmission, although volumes were higher realizations declined for the same reason as for natural gas transmission. Higher LNG prices and rupee depreciation resulted in strong topline growth for the natural gas trading segment. While petrochemicals volumes were lower better realizations had an offsetting impact.

LPG segment impacted by higher subsidy burden

For Q4 FY12, GAIL accounted for a subsidy share of Rs13,980mn which included Rs3,355mn for under provisioning of Q3 FY12 and Rs10,625mn for Q4 FY12. This was in comparison to Rs9,017mn in Q4 FY11 and Rs5,361mn in Q3 FY12. This resulted in 40% yoy fall in revenues for the LPG and liquid hydrocarbon segment.

OPM flat on yoy basis but falls 133bps sequentially

During Q4 FY12, GAIL reported an operating profit of Rs7.7bn down 40.4% yoy, while OPM slumped 713bps yoy. This was way below ours and street expectations. In terms of segment-wise performance, EBIT margins for all segments were down sharply except petrochemicals. Fall in EBIT margins for natural gas transmission and LPG transmission segments was on the back of one time provision for retrospective reduction in tariffs on Mumbai and Agartala networks. Natural gas trading segment margins were down owing to lower proportion of LNG which has higher marketing margins. LPG and liquid hydrocarbon segment reported a negative EBIT of Rs3.3bn on the back of the subsidy burden.

Depreciation was higher by 28% owing to capitalization of assets with respect to new pipelines. Furthermore, interest cost too was up by 53% due to higher debt to finance pipeline projects. However, other income jumped from Rs525mn in Q4 FY11 to Rs2.5bn in Q4 FY12 on the back of higher dividend income from ONGC (in FY11 it was received in Q3 FY11). Consequently PBT fall was only at 36% yoy as compared to operating profit fall of 40% yoy. 260bps increase in effective tax rate resulted in higher decline in PAT (38% yoy).

Key takeaways from the analyst meet

• The company expects transmission volumes to rise to 120mmscmd in FY13
  

• The company has lined up a capex plan of Rs75bn for FY13, more than 65% of which will be spent towards pipelines and petrochemical expansion
  

• In FY12 the company had brought in 16 spot cargos of LNG and in FY13 it plans to import 30 spot cargos depending on availability of Dabhol LNG terminal
  

• Commencement of operations at Dabhol LNG terminal has been delayed to October 2012. Breakwater for the project is expected to commence operations within 2 years which will allow the project to run at 100% utilization levels
  

• Production from A1 and A3 blocks of Myanmar is expected in June 2013 and the pipeline to China is on schedule
  

• With respect to Turkmenistan-Afghanistan-Pakistan- India (TAPI) pipeline, the company has guided for a capex of US$6-7bn and the pipeline length is expected to be around 1,760kms. It supply 40mmscmd to India, 40mmscmd to Pakistan and 10mmscmd to Afghanistan. It is expected to commence supplies by 2016-17.
  

• Dabhol-Bangalore pipeline is being constructed in two phases. First, a spur line is being developed for Goa, which will be ready to operate by August 2012 and in second phase trunk line up to Bangalore will be developed by December 2012.
  

• Kochi-Bangalore pipeline is also being developed in two phases. First, spur lines will be made available in and around Kochi which will be ready in two months and then trunk line will be developed up to Bangalore by December 2013.

Maintain BUY rating but cut target price target to factor flat transmission volumes in FY13

GAIL has witnessed steep correction of 16% in the past two months with growing concerns over gas supplies especially in the light of declining gas production at KG-D6. However, with increase in LNG imports and commencement of production from marginal fields of ONGC, we expect the transmission volumes to increase in FY13. Over the longer term, with new fields expected to commence production, increase in LNG capacities, imports via pipelines and CBM production transmission volumes will gather momentum. Under such scenario, we find the current valuations attractive at P/E of 9.7x FY14E EPS. We maintain BUY with a revised 9-month price target of Rs365.