GAIL’s LPG segment has benefited in H2FY17 from higher realisations & lower domestic gas prices. Petchem too has gained from stabilisation & ramp-up of Pata II. However, further upside in both could be capped—LPG realisations could come off post seasonal strength and with crude softening, while domestic gas prices are finally set to rise from 1 April. Petchem margins too could be capped if GAIL has to absorb its high cost LNG as feedstock.
Gas volume growth may be slowing: Gas transmission revenue/Ebitda rose 14%/22% in 9MFY17, led by 9% volume growth and 4% average tariff increase. Management expects volume growth to moderate to 5% per annum for the next 2 years assuming extension of the power e-auction LNG scheme, though this could be at risk in the near term if the scheme is not extended beyond March 31. Meanwhile, tariff review for the remainder of GAIL’s pipelines may be back-ended.
Market in denial on LNG trading risks: 8.2 MMTPA of GAIL’s contracted LNG remains without buyers. At $3 Henry Hub, landed cost of US LNG into India is $8 vs. equivalent oil-linked spot cargoes at $5.7-7.5. At the upper end, the losses on these contracts could impact GAIL’s profits by 70%. In the process, GAIL has to offtake higher oil-linked volumes at a premium to spot. The inability to enter into a 1:1 swap highlights how costly this LNG is.
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Earnings growth may reverse in FY19e: We forecast FY19e Ebitda/PAT for GAIL to decline 5%/7% driven by LNG trading and petchem. We are concerned the market is pricing GAIL on peak earnings. GAIL’s multiples have tended to derate prior to an anticipated decline in earnings. We raise our TP to Rs 347 on a roll-fwd to FY18e and increase in FY18-19e earnings by 5-6%. Maintain Sell.
Strong earnings momentum, but margins may have peaked: GAIL’s LPG segment is benefiting in H2FY17 from higher realisations and lower gas prices. Petchem too is gaining from stabilisation and ramp up of Pata II. However, further upside in both could be capped — LPG realisations could come off post seasonal strength and with crude softening of late, while domestic gas prices are set to rise from April 1 . Petchem margins could also be capped in the near term if GAIL is forced to use more of its high-cost contracted LNG if it is unable to find buyers for it.
Gas pipeline tariff upside has played out for now, while volume growth may be slowing: Gas transmission revenue/ Ebitda is up 14%/22% in 9MFY17, though corresponding volume growth is 9%. This was mainly because of a 4% increase in average tariffs with six pipelines witnessing a reset in FY17. Management expects volume growth to be more modest at 5% p.a. for the next two years assuming extension of the power e-auction LNG scheme. Meanwhile, while new tariffs are due for the remainder of GAIL’s pipelines, this is unlikely in the near term.