GAIL (India) Ltd (Q1 FY13)

CMP Rs356, Target Rs366, Upside 2.8%

• Net sales rise 25% yoy on the back of higher revenues in the natural gas trading and LPG & liquid hydrocarbon segment

• Natural gas transmission volumes fall 6.3% yoy and 5% qoq on the back of falling natural gas production at the KG-D6 field

• OPM declines 44bps yoy to 17.3% but registered a sequential increase of 998bps; sequential improvement was on the back of one time provisions for the tariff cuts made in Q4 FY12

• Amongst segmental EBIT margins, gas transmission and petchem segments witnessed declines while LPG transmission, Natural gas trading and LPG & liquid hydrocarbons saw an increase

• Subsidy burden was at Rs7bn, which was lower than our estimates

• Downgrade to Market Performer but maintain 9-month target price of Rs366

Strong revenue growth in spite of fall in volumes

Gail (India) Ltd reported net sales of Rs111bn, an increase of 25% yoy. Sales were in line with estimates. Growth in the topline was driven by 28.3% and 31.8% yoy jump in revenues of natural gas trading and LPG & liquid hydrocarbon segment. For natural gas transmission, volumes were lower by 6.3% on the back of decline in KG-D6 production. For LPG transmission, although volumes were higher, realizations were on the lower side. Higher LNG prices and rupee depreciation resulted in strong topline growth for the natural gas trading segment. Petrochemicals segment disappointed with a 25% yoy fall in sale volumes on the back of weak demand environment for polymers in the domestic market.

Lower subsidy burden translates into improved performance for LPG segment

For Q1 FY13, GAIL accounted for a subsidy share of Rs7,000mn as compared to Rs13,980mn in Q4 FY12 and Rs6,819mn in Q1 FY12. The provisioning was lower than our estimates. As a result, the realizations for the LPG & Liquid Hydrocarbon segment rose by 43% on yoy basis and the EBIT margins of the segment jumped 12.7 percentage points on yoy basis.

During Q1 FY13, GAIL reported an operating profit of Rs19.2bn up 21.9% yoy, while OPM declined 44bps yoy. On a sequential basis though, operating profit was up 150% while margins expanded 998bps. Sequential improvement was owing to the one-time impact in Q4 FY12 of tariff cuts across few of company’s pipelines with retrospective effect. In terms of segment-wise performance, fall in EBIT margins of petrochemicals and natural gas transmission business was more than offset by improvement in EBIT margins of the LPG transmission, natural gas trading and LPG & liquid hydrocarbon segment. Fall in petrochemical EBIT margins was on the back of sharp decline in volumes.

Depreciation was higher by 22% owing to capitalization of assets with respect to new pipelines (Bawana-Nangal pipeline). Furthermore, interest cost too was up by 182% due to higher debt to finance pipeline projects. Other income also declined from Rs647mn in Q1 FY12 to Rs378mn in Q1 FY13. Consequently PBT grew 16.8% yoy as compared to 21.9% yoy increase in operating profit. Higher than expected operating profit resulted in an outperformance on bottomline front as compared to our expectations.

Downgrade to Market Performer

With sustained fall in KG-D6 production and no expectation of near term revival, we don’t foresee a meaningful trigger for earnings in the near term for GAIL. Over the longer term though, commencement of new LNG terminals and start of production from new E&P fields will lead to improved performance. Petrochemicals segment too is expected to see continued pressure in terms of earnings with global economic slowdown in the backdrop. We downgrade our rating to Market Performer but maintain our 9-month price target of Rs366.