Strong profit of Rs 29 bn (c9% q-o-q) in Q1 driven by record marketing Ebitda of Rs 24 bn had little meaning as supply disruption in the current quarter puts future earnings at risk. Company indicated that its LNG cargoes from Gazprom Marketing and Trading Singapore (2.5mmtpa contract) have been disrupted since June and will likely impact c6mmscmd of marketing volumes. Company will try to honour its external sales contract by reducing any extra supply and maintaining its minimum supply as per the contract, by taking some extra cargoes from the US and reducing its own consumption at the Pata petrochemical complex.
This should hurt the profitability of the transmission, marketing and petrochemical businesses. It also expects a further increase in domestic gas price which should negatively impact the profitability of its LPG segment. Persistently high gas prices are also impacting the profitability of its transmission business on account of internal consumption but should be recovered by tariff revisions in the future. Also, the current environment of weak naphtha spreads over crude is hurting the relative attractiveness of its gas-based petrochemical plant.
Longer-term momentum remains largely unchanged: The currently high global prices are a spanner in the works for gas demand growth. However, we believe increasing city gas distribution penetration and increased production of gas from Reliance will lift gas demand. The current utilisation rate for GAIL’s pipelines is c55%. As demand increases, higher utilisation should flow straight to the bottom- line. In addition, a significant part of its pipelines are still under construction. As these are commissioned, demand should rise and improve the company’s ROE. GAIL is also ramping up in the renewables space.
Risk-reward favourable: We cut our FY23e-24e EPS estimates by 8-11% due to lower transmission and petchem volumes and higher domestic gas prices impacting LPG profitability. We also introduce FY25e EPS. The stock trades at a 1-year forward PE multiple of 9x, which is at a 25% discount to its 10-year mean despite much improved visibility on demand and project commissioning. We retain Buy rating as GAIL should be a key beneficiary of the increasing share of gas in the energy mix. We lower our TP to Rs 185 (from Rs 205). Key downside risks: 1) lower-than-estimated transmission tariffs and gas volumes; 2) fall in petchem spreads versus our assumptions; and 3) regulatory unbundling of its gas transmission business at significantly below its replacement costs; and 4) persistently high gas prices.