GAIL’s third quarter earnings were well ahead of estimates driven primarily by better trading profits and to a lesser extent by better petrochemical and LPG earnings. Rasgas renegotiation which was formally announced at the end of December has come as a major relief and is the main reason behind our upgrade of the stock from Underperform to Hold. However, given the rally in the stock in the last three months, most catalysts now seem to be priced in.
Large beat in Q3 led by strong trading performance.
GAIL reported strong earnings in Q3 with Ebitda 34% above our estimate. The biggest positive surprise was in the natural gas trading segment—management guided for continued strong performance in trading over the next few quarters. Earnings in petrochemical and LPG businesses were also better than expectation. However, given management commentary that GAIL used almost entirely spot LNG in Q3 vs. mainly Rasgas in Q2, the improvement in earnings in petrochemicals was below par in our view. Higher other income and lower taxes led to 68% beat in net profit.
Rasgas contract revision a major relief
In December-end, PLNG announced renegotiation of Rasgas LNG contract. The new price formula is linked to the three-month average Brent price (instead of five year JCC with a floor and a cap earlier) and implies a price of $6.5/mmbtu (fob) from January vs. over $12/mmbtu till December. This is a major relief to GAIL’s petrochemical business which uses Rasgas as feedstock as well as its trading business which sells Rasgas to other consumers.
Raising estimates, price target to reflect lower Rasgas price, new oil price deck and roll forward by a year: We increase our FY16/FY17 earnings estimates by 10-13% to reflect lower Rasgas/domestic gas prices and our new oil price deck. We also introduce FY18 estimates which becomes the basis for our new fair value for GAIL. As a result our fair value for GAIL increases to R382 vs. R272 earlier.
Upgrade to Hold; most catalysts priced in
We upgrade GAIL to Hold from Underperform. We note that given the rally in the stock over the last 3 months most catalysts such as higher crude price (up to $60/bbl), positive impact of lower gas price, transmission tariff revision and pick up in transmission volumes seem to be priced in.
Our fair value of R382 (prev. R272) implies 11x FY18 P/E (price-to-earnings ratio), in line with historical median.
Key risks: Higher/lower crude price; higher/lower transmission tariffs/volumes; higher/lower trading profits