Thursday, August 9, 2012

>GAIL: Lower subsidy burden

Lower subsidy burden, better gas trading and petchem offset muted transmission performance

GAIL reported superior earnings during Q1 backed by lower subsidy burden at Rs7bn, higher petchem realisations, expanded gas trading margin despite muted transmission performance with 5% QoQ decline in transmission volumes from 116mmscmd to 110mmscmd. However, transmission tariffs were robust probably due to take or pay component. We believe the performance in Q1 was better due to one offs and incrementally the performance is likely to be under pressure due to declining transmission volumes and higher subsidy burden. GAIL is likely to face multiple headwinds in FY13 which is likely to affect its performance with decline in earnings. Thus we maintain our ‘Neutral’ rating on the stock.

Revenues buoyed by lower subsidies, higher petchem realisations: GAIL reported 25.0% YoY and 5.9% QoQ jump in revenues at Rs111.1bn backed by lower subsidies at Rs7bn and higher petchem realisations at Rs85,303/ton despite lower transmission volumes and petchem sales.

Trading margins benefit performance: Natural gas trading business benefitted from earlier spot LNG inventory which was at lower cost thus aiding margin expansion. However, declining KG D6 volumes along with overall lower spot LNG imports led to 5.0% QoQ decline in transmission volumes at 109.8mmscmd. Petchem realisations and profitability was robust due to rupee depreciation and averaged Rs85,303/ton despite 44.1% QoQ decline in sales volumes at 66,000tons.

Asset capitalisation leads to higher depreciation and interest outgo: GAIL’s depreciation and interest outgo jumped by 21.7% and 182.7% YoY at Rs2.2bn and Rs588mn due to capitalisation of pipelines during Q4FY12 and capitalisation of Bawana-Nangal pipeline in Q1. However, lower subsidies, better petchem and gas trading performance led to 15.1% YoY and 134.6% QoQ jump in profitability at Rs11.3bn.

No near term catalyst for the stock: GAIL’s transmission volumes are likely to remain depressed in FY13E owing to declining KG D6 volumes before reviving in FY14E owing to incremental LNG re-gasification capacity (Dahej and Kochi). However, rupee depreciation is likely to support petchem performance despite international polymer prices remaining stable. Natural gas trading business is likely to come back to normalcy from Q2 with lower margins. Capitalisation of new pipelines without any meaningful contribution to revenues is likely impact earnings by inflating the depreciation and interest costs going forward. We have lowered our transmission volume and tariff assumptions while raising petchem price assumptions. Growth drivers for GAIL are likely to play out only after FY14E and hence we do not expect any trigger for the stock in the near to medium term. We thus maintain ‘Neutral’ on the stock with a revised SOTP based price target of Rs349 (earlier Rs373).