Adverse situation may be reversed; outlook remains strong over the medium term; ‘Buy’ maintained
Gail’s business conditions have turned decidedly weak in the past month with LPG realisations set to fall 30% by January and US LNG trading margins set to weaken from rising HH & charter rates and lower Asia LNG prices. Yet, this may all reverse. The crude supply surplus may ease if OPEC cuts and long dated HH is still soft while petchem Ebit may rise as could gas trans. if HBJ/GREP tariffs rise. With valuations also modest at 10.5x adj. FY19E P/E, our Buy stays.
Near term: Gail’s business conditions have deteriorated markedly in the past month. LPG and Trading profits are set to weaken, e.g., and perhaps polymers too where prices have held up but production could fall after a strong Apr-Oct as Gail undertakes a planned shutdown.
LPG: In LPG, Aramco has cut LPG prices by 19% in November to reflect lower crude prices (and weak propane cracking margins), with futures suggesting another 20% cut in December. With domestic prices lagging Aramco by a month, Gail’s realisations may fall 30% over Nov-Jan, therefore, cutting gross margins in half, hurt also by the 10% rise in APM gas prices.
Trading: A bigger squeeze is probably coming in trading. US gas prices have shot up to $4.7 on weather and below-trend storage with spot LNG charter rates at a record too. Meanwhile, Asia LNG prices have eased on lower crude and a more orderly gas demand-supply in China unlike last winter leaving US LNG trading margins negative for December, in our estimates.
Wane: Trading margins may fall sharply from the Q2FY19 highs, therefore, even if hedges, swaps, lags and lack of detail on contract terms make it hard to pin it down accurately. With LPG/Petchem likely softer in 2HFY19 too, the record Q2FY19 is unlikely to soon be repeated.
Reverse: Yet, these may soon reverse. Oil demand has held up well in China and India, and OPEC may cut supply too. The steep 25% fall in Brent, exacerbated by managed-money sell-offs, may well prove transient, therefore, with US gas prices also set to ease in the spring. Indeed, long dated prices are unchanged despite the 70% spike in front month prices in the past two months, with Dec20 prices actually falling 5-10% in the past year to $2.8.
Tariffs: With petchem Ebit also likely to rise (better volumes/mix & lower costs), we expect a 15% FY18-21e EPS CAGR with room for upside. The regulator recently hiked blended tariffs for three pipeline networks by 80% (lifting EPS by 4-5%), e.g., and is evaluating changes for the more crucial HBJ/DVPL/ GREP network where a 10% change impacts EPS by 4-5%.
Buy: Even otherwise, though, valuations are modest at 10-11x adj. FY19-21e P/E (well below Asian gas peers & Indian market). Our Buy stays (Rs 450 PT).