GAIL: Transmission/marketing margin concerns resurface

Analysts, while watchful, don't expect any major impact for return on equity

Recent news reports that the government could reduce the transmission/marketing margins of gas transmission companies such as GAIL have again cropped up. It is believed the government might be looking at such options to cushion the impact of increased APM gas prices on certain sectors, particularly if gas pooling is carried out. The reports suggest allowable transmission and marketing margins might be reduced by up to 50 per cent and 75 per cent, respectively.

Any significant cut in margins will hurt GAIL, as transmission and trading account for 40-45 per cent of its Ebitda (earnings before interest, taxes, depreciation, and amortisation). Analysts at JPMorgan estimate a 10 per cent cut in transmission margins would lead to an earnings per share (EPS) reduction of six to seven per cent in earnings for FY16-17 and a 10 per cent cut in marketing margins would lead to a reduction of five per cent in FY16-17.

Many analysts feel nothing drastic will come, given the recent judicial orders, especially in the Gujarat State Petronet Ltd (GSPL) appeal, the source of their confidence. Recently, the appellate tribunal ordered the Petroleum and Natural Gas Regulatory Board (PNGRB) to rework transmission rates and ensure a minimum return on equity of 12 per cent. Thus, it is believed the regulator/government will be more cautious on rates and margins. GAIL’s stock, thereby, has not reacted much to the news and continues at levels similar to last week.

Many other factors will reflect positively on GAIL. First, it is expected to benefit from doubling of its petrochemical capacities at Pata in Uttar Pradesh from the second half of FY15. Second, the government is looking at providing clarity on subsidy sharing for upstream companies such as ONGC, Oil India and GAIL. This will be a positive, as the subsidy mechanism has been ad hoc, with clarity over the amount to be shared by upstream companies coming only at the end of each financial year. Analysts at Kotak Institutional Equities remain optimistic and are factoring in a nil subsidy share for GAIL from FY16. Third, GAIL recently tied-up to import 2.5 million tonnes of liquefied natural gas (LNG) every year for two decades, which will drive volumes from 2017.

Analysts at JPMorgan say progressively lower subsidies, bottoming out of domestic gas volumes and increasing LNG imports will aid earnings, while capex intensity is also set to decline. While higher gas prices could impact petrochemicals' profitability, execution risks and the possibility of rate revisions are lower than anticipated. Hence, analysts see the risk-reward ratio as fairly balanced. The consensus target for the stock, trading at Rs 469, stands at Rs 478 according to analysts polled by Bloomberg since November.