Multiple positives spell gain for GAIL

Rising gas demand, growing pipeline infrastructure, unified rates set to boost profit

GAIL’s share price has risen 24 per cent from a May low, on the back of multiple triggers. Rising natural gas prices have eased concern on placement of higherpriced liquefied natural gas (LNG) cargoes from the US. Improvement in transmission, distribution and trading segment volumes and profitability are positives, as is uptick in the petrochemicals business. Most segments did better than expected in the June quarter.

The other positive is the government’s clarification about not splitting the natural gas transmission and trading/marketing business into independent entities. The ministry clarified the government’s intention of ensuring GAIL’s complete focus on building of gas infrastructure and sales. It did indicate selloff plans for the petchem segment, given the need to meet divestment targets. These plans are, however, at a nascent stage. The government will also wait for the right valuation.

The Street is not worried about sale of non-core petchem segments, as it is a cyclical commodity business that sees lumpiness of revenue. The segment had contributed less than 10 per cent to overall revenue and profit during the June quarter. Analysts at ICICI Securities say if the petchem business is sold, the return ratios would improve, benefiting the shareholders. The latter might also get rewarded with a special dividend that the government is looking for, from sale of the petchem business.

Nilesh Ghughe at HDFC Securities says that while this will lead to reduction in the company’s fair value, the petchem business is non-core. Growth will be driven by gas transmission and distribution.

GAIL’s major capital expenditure is directed at increasing its pipeline infrastructure, indicating the focus on its transmission business. The company will add about 4,900 km to the existing 11,167 km over FY19-22 (annual addition of 9.5 per cent to capacity, from 0.85 per cent annually over FY13-18). The company will be spending 78 per cent of the overall capex spend of ~118.3 billion over FY19-20, on pipeline capex.

Rising industrial gas demand, city distribution and automobile demand will be major drivers over time. The recent city gas distribution auctions will also add to gas segment volumes.

The other positive is inclusion of natural gas under the Goods and Service Tax (GST). Availability of input tax credit under the GST regime (unlike value added tax) is likely to reduce the end-user cost of natural gas by five to 19 per cent, estimates Ghuge. This could be a strong demand driver, as natural gas will then become 12-18 per cent cheaper (six to 13 per cent cheaper now) than fuel oil.

The unified tariff (rate) method for computing transmission charges could be another trigger. The rates will add to revenue and drive availability in remoter areas at affordable fees, say analysts. This will also enable higher utilisation of new and existing pipelines, and ensure 18 per cent pre-tax return on investment, they add.

Analysts at CLSA say the inclusion of gas in GST, rate hike for the Dahej-Hazira-Uran pipeline, curb on petcoke use and more city gas wins are triggers during the second half of this financial year. Inclusion of natural gas under GST within the next six months could add ~35 a share to its fair value.

Analysts at Jefferies have increased the FY19-21 estimated earnings per share by one to three per cent and maintain a 'buy' rating on the stock, with a target price of ~450. They say the new projects will improve gas transmission profit in FY20-21 even if rates do not rise.