Near-term concerns outweigh GAIL's attractive valuations, growing network

Street worried over the proposal to restructure the company, profitability of petrochemicals business and placement of high-priced US contracts

State-owned gas utility, GAIL (India)’s investment plan to expand the National Gas Grid and city gas distribution network over the next five years, is a positive move. The country’s largest gas pipeline operator, which has more than 11,000-km of pipeline network is expected to benefit further from these investments in the long run. However, there are near-term concerns, which are likely to weigh on the company’s financial performance and the stock.

The company had seen disappointment over new tariffs provided by the regulator for some of its pipelines such as Hazira-Vijaipur-Jagdishpur (HVJ). This led analysts to cut their earnings estimate for GAIL, and the stock price too has corrected by almost 30 per cent between June and early August. The stock, which scaled to its 31-month low on August 8, may have seen marginal gains post an in-line June quarter (Q1) performance, but the same was helped by better-than-expected earnings in its trading segment. Most other businesses saw weakness and volumes were lower across segments.

For instance, despite soft prices of key input liquefied natural gas (LNG), the petrochemicals business posted an operating loss, hurt by weak realisations.

The natural gas transmission segment saw volumes decline two per cent year-on-year owing to shut down of some fertiliser plants in the country. Although this segment’s earnings before interest and tax (EBIT) still improved by 22 per cent year-on-year in Q1, volumes in liquefied petroleum gas (LPG) and liquid hydrocarbons businesses also fell due to lower off-take by customers, thereby impacting their profits.

It was the 50 per cent jump in profits of the gas trading segment, which pulled up the overall performance of GAIL. The improvement in margins was surprising looking at the weak demand-supply situation in the country.

The concerns on placement of high-priced US gas contracts also remain even though GAIL has consistently been successful in placing them and reporting good numbers for the past few quarters. Analysts at Motilal Oswal say that the company has hedged sufficient US cargoes for FY20 and FY21, though it remains to be seen how these US contracts work in an environment of increasing LNG supply glut. Also, on the domestic front, the extremely challenging macro environment are marked by falling Asian spot LNG prices, which are currently just $2.5 per mBtu (million British thermal unit) lower than the landed cost of US LNG, say analysts. Clearly, the Street will remain watchful on the how trading margins trend moving forward, while the near-term outlook for petrochemicals’ margins and other segments remains subdued.

Among the few near-term positives is the commissioning of pipelines such as Kochi-Mangalore. The company expects to complete the Kochi-Mangalore pipeline in a few months and this can provide some volume growth as can the increased utilisation at Petronet LNG’s recent capacity ramps-up that can boost transmission volumes, says Nilesh Ghuge at HDFC Securities. Ghuge however expects the Jagdishpur-Haldia and Bukaro Dhamra pipeline (JHBDPL) to boost volumes post second half of FY22.

In the long run, there is no doubt that GAIL remains well-placed looking at the strong natural gas demand in the country helped by piped natural gas and compressed natural gas, which is to continue growing and, the tightening norms on industrial pollution which would help drive gas transmission volumes.

However, the lack of clarity on plans to restructure the company is also proving to be an overhang. While analysts at Motilal Oswal have lowered their valuation multiple from 9x to 8x due to concerns on restructuring, analysts at Prabhudas Lilladher, who say that valuations remain attractive, add that concerns on demerger of pipeline network remains an overhang. They have also tweaked their FY20/21 estimated earnings to incorporate annual report changes and expect GAIL’s capital expenditure trajectory to pick up as all businesses (excluding pipeline) operate at near peak levels.