GAIL?s reported net profit of Rs 9.7 bn was about 10% lower than our estimates due to lower petrochemical sales and lower liquid production. However, its share in upstream?s contribution to under-recovery was 8% versus 9% in the previous quarter. Gas transmission volume bounced back to 120 mmscmd (million metric standard cubic metre per day) as Panna-Mukta fields came on-stream and fresh LNG flowed through the pipes to make up for the lost volume from other domestic fields.
We believe that the LNG flow will barely make up for the decrease in the domestic gas flow. The new LNG will come from recent volume of 1.1 mt (4.2mmscmd) contracted by Petronet LNG and 0.5 mt (2 mmscmd) contracted by GAIL. This is slightly less than the decline in KG-D6 volumes. We maintain our estimates that the FY12 and FY13 transmission volume will be about 121 mmscmd and 130 mmcmd, respectively. This implies that utilisation of the fully expanded HVJ (Hazira-Vijaipur-Jagdishpur) network will be a poor 60% in FY12 and 70% in FY13.
We maintain our earnings estimates for FY12 and FY13. We value the firm on a PE (price-to-earnings) multiple for its core business and investments on market value. We have used a 1-yr forward PE multiple of 13.5x on FY12 EPS (earnings per share). We maintain our target price of Rs 527 with a Neutral rating.
We believe investment risks include any downward revision in GAIL?s tariff, a higher-than-expected share in under-recovery, or an inability to obtain requisite approvals from the regulator. Potential catalysts include: updates on timely completion of its pipelines, new gas supply visibility, or discovery in its exploration blocks.
GAIL transports nearly 71% of the total gas consumed in India. Given its pipeline coverage, last-mile connectivity to large customers, and proactive expansion of its transmission network, we think GAIL will continue to aggregate the bulk of the increasing supply and will maintain its dominant position in the Indian gas transmission segment.
However, lower-than-expected domestic gas volume and the continuing high price of LNG cargo means that the transmission volume of GAIL will remain under pressure. We expect utilisation of expanded HVJ network to be a poor 60% in FY12 & 70% in FY13. The higher tariff for the expanded network on the other hand is not enough to offset the weaker volume. Better petrochemical margins and lower percentage of share in under-recovery will likely keep the stock from bearish pressures as well.
Our target price is Rs 527/share, comprising the sum of its core business plus investments on account of increased value of investments.
We continue to value the core businesses of natural gas and LPG transmission, natural gas marketing, petrochemical and LPG/other hydrocarbons at PE of 13.5x on FY12e EPS. While the average PE of utilities is 14-15x (times), we have adjusted our multiple to reflect uncertainty related to under-recovery concerns. We believe a PE of 13.5x aptly reflects the nature of GAIL?s business, reflecting a 21% ROE (return on equity) and 5.0% long-term growth.