Higher oil price betters prospects

By: | Published: June 23, 2018 1:53 AM

GAIL has been our top India oil & gas (O&G) pick since Jan-17. With higher oil prices, the outlook gets even better as petchem/LPG realisations move up, while feedstock costs don’t rise much as domestic gas/Henry Hub (HH) prices remain subdued.

Though the stock performed well in 2017, the weakness this year, despite an oil price rally, has been surprising.

GAIL has been our top India oil & gas (O&G) pick since Jan-17. With higher oil prices, the outlook gets even better as petchem/LPG realisations move up, while feedstock costs don’t rise much as domestic gas/Henry Hub (HH) prices remain subdued. Investor fears over HH contracts losses have dissipated. Rather, GAIL could surprise with strong profits. Delays in unified/pooled tariff implementation have been disappointing. However, with the politically sensitive Urja Ganga project starting, the case is now stronger for unified tariff. EPS momentum remains strong — after 65/21% growth in FY17/18, we see 27/31% growth in FY19/20F.

Higher oil price improves outlook

Though the stock performed well in 2017 , the weakness this year, despite an oil price rally, has been surprising. GAIL benefits from higher oil prices as petchem/LPG realisations move up. Moreover, we believe feedstock costs will not rise much as domestic gas/Henry Hub prices have remained subdued. However, further delays on transmission tariff hikes have been disappointing. But, with a progressive regulator in place, aggressive new CGD licensing plans, and new trunk pipelines/CGDs starting soon, tariff pooling looks even more certain to us. GAIL should also be a key beneficiary of likely inclusion of natural gas in goods and services tax (GST).

With unified tariffs, legal unbundling is likely

For equitable and fast growth, GoI has pushed for unified/pooled transmission tariffs. But, stakeholders see GAIL’s current practices (unequitable open access and bundled contracts) as restrictive, and have demanded unbundling. Both GoI and the regulator PNGRB seem keen on unbundling. We think legal unbundling can start soon, and it is not difficult or a big negative. Gas transmission business should clearly benefit from legal unbundling (higher volumes/returns), but gas marketing may get competitive for new volumes. But, GAIL’s sourcing contracts are competitive and volumes can be sold globally. Ownership separation can be cumbersome, long-drawn, and is unlikely soon, in our view.

Tariff hike now likely in FY20F; earnings momentum strong

As we assume a 30% unified tariff hike from Apr-19, we cut our FY19F EPS by 15%, but marginally raise FY20F EPS. The earnings momentum remains strong – after 65/21% EPS growth in FY17/FY18, we expect 27/31% growth in FY19/FY20F. We carry forward our SOTP valuation to FY20F from FY19F, and raise our target price to `460, implying 36% potential upside. The stock is trading at 10x FY20F P/E.

We have highlighted a sharp earnings revival for GAIL in FY17, followed by continuing earnings growth as all key core segments are likely to do well. Indeed, GAIL’s earnings have been strong. Earnings rose by 65% in FY17, and despite weak numbers in Q3 (several one-offs) and Q4 (marketing /petchem impacted), earnings grew
further 21% in FY18.

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