Q1 results were in line with estimates; upgraded to ‘Buy’ as the stock is pricing in risks from US LNG contracts; estimates fine-tuned.
The recent sharp correction in GAIL stock offers an opportunity to Buy, as our reverse valuation exercise suggests that the stock is trading at 11X utility EPS pricing in adequate risks from US LNG contracts. We remain sanguine on improvement in operating performance across key segments, except gas marketing wherein we have factored $0.5/mn BTU of impact from US LNG. Upgrade to Buy from Add with TP of Rs 440 (Rs 435 earlier). Q1FY18 results were in line.
Q1FY18 results reflecting strength in profitability across segments
GAIL’s adjusted Ebitda at Rs 17.4 bn and net income at Rs 9.2 bn, were 2% ahead of estimates, as decline in gas volumes was offset by higher-than-expected LPG/petchem sales volumes. Reported numbers were boosted by a write-back of Rs 1.6 bn in employee costs pertaining to excess provision related to pay revision provided in Q4FY17. Steady gas transmission Ebit despite lower volumes/tariffs: Ebit remained flat at Rs 5.8 bn in Q1FY18, despite 2% q-o-q decline in volumes to 99.9 mcm/d, attributed to loss of volumes under LNG auction scheme, and 3% lower tariffs at Rs 1.25/scm.
Robust LPG/LHC EBIT led by higher volumes: Adjusted LPG/LHC segment Ebit remained strong at Rs 5.2 bn driven by 6% q-o-q increase in volumes to 293 ktons, which was offset by 6% q-o-q decline in realisations to Rs 33.7/kg. Higher volumes were attributed to rich gas availability. Petchem impacted by shutdown: Petchem Ebit fell to Rs 0.1 bn on lower polymer sales volumes at 131 ktons due to the shutdown in April-May, which was partly offset by 8% q-o-q increase in realisations to Rs 102/kg. Plant operations normalised in June-July. Improvement in gas marketing Ebit: GAIL’s gas marketing Ebit jumped 21% q-o-q to Rs 3.2 bn despite 5% decline in volumes to 78.4 mcm/d reflecting strength in marketing margins.
Fine tune estimates; expect strong growth in Ebitda across segments, except gas marketing
We revise EPS to Rs 25.9 (-4%) in FY2018e and Rs 28.7 (-0.4%) in FY2019e and raise SoTP-based TP to Rs 440 from Rs 435, factoring in (i) lower gas volumes, (ii) higher LPG/LHC volumes and (iii) other minor changes. We expect GAIL to deliver strong growth in Ebitda across utility and commodity segments—(i) gas transmission led by increase in volumes and higher regulatory tariffs and (ii) LPG/petchem production led by higher volumes and likely higher crude prices.
Reverse valuation implies stock pricing in risks from US LNG
Our reverse valuation implies that the stock is trading at inexpensive 11X gas business EPS, adjusted for the value of investments and commodity segments. We compute $0.5/mn BTU of potential loss on 4mt of US LNG volumes, factored in our gas marketing Ebitda for FY2019-20e — we rule out material loss seeking comfort from (i) placement of crude-linked LNG volumes at higher-than-spot price in the current environment, (ii) high implied marketing margins of $1/mn BTU earned by GAIL on spot volumes and (iii) possibility of shipping swaps that may reduce costs by $0.5/mn BTU. (i) India’s growing LNG appetite directed by initiatives in fertiliser and CGD sectors and (ii) likely rebalancing of global LNG/crude markets will anyway mitigate risk from US LNG contracts in three to four years.