After good Q2, second half may be better for GAIL

Firm earnings outlook should allay concerns on higher-priced new contracts

The Street’s confidence on GAIL should firm up further following its strong all-round performance in the September quarter (Q2) and a healthy outlook. GAIL has continued to see improvement in profitability over the past year, which has pushed up its share price. Though concerns on higher-priced (take or pay) US LNG contracts, commencing this month, restricted gains in the counter, the domestic regulator’s proposal on implementation of unified tariff (rates) has boosted sentiment from end-September. If implemented, it can significantly improve GAIL’s earnings visibility. Petronet’s renegotiation of Australian contract also raises hopes of GAIL successfully re-negotiating its high-priced US contracts. 

The highlights of Q2 performance have been the rise in volumes across segments. As petrochemicals continues its strong show, the largest beat was in gas transmission, where higher volumes and realisations coupled with lower operating expenses boosted the segment’s and GAIL’s profitability. Thus, as revenue grew five per cent over a year and nine per cent sequentially, earnings before interest, tax, depreciation and amortisation (Ebitda) at Rs 2,069 crore grew 40 over a year and 23 per cent sequentially. This helped net profit grow 42 per cent over a year and 28 per cent sequentially.

Analysts expect the second half to be stronger. This is despite coal availability improving (leading to normalisation of gas demand from the power segment) and expected moderation in gas tariffs. The LPG/hydrocarbons segment should compensate, while the petchem segment continues to witness improving performance. LPG prices have firmed up to nearly Rs 40 a kg in November (from Rs 28 a kg in Q2) highlight analysts at Nomura, who after accounting for rising gas costs from October 1 (from $2.5 to $2.9/mmbtu), estimate GAIL’s LPG business Ebit improving by Rs 200-250 crore in the December quarter. Even petchem realisations are soft, GAIL should benefit both from higher volumes and lower operating costs, adds Nomura. Hence, GAIL remains its top pick in the Indian oil & gas space.

On US LNG cargoes, the management has guided analysts that bulk of volumes have been placed and 30 per cent of contract volume (1.7-1.8 million tonne) has been destination swapped, substantially reducing shipping costs. Gas prices, too, inching up, thereby reducing the gap with US gas contracts. All these should help ease concerns. Analysts at Antique Stock Broking say headwinds with respect to US LNG cargoes appear to be waning with the company's proactive marketing efforts. Kotak Institutional Equities, after modelling sharply lower contribution from the gas marketing segment, adequately factoring in substitution of high-margin spot/medium-term volumes and break-even in US LNG contracts, say the stock is trading at reasonable 12 times its core business earnings.