Multiple earnings triggers for GAIL amid risks of subsidy sharing

Higher crude oil prices support GAIL's earnings by way of rising realisation in petrochemicals business and higher trading margins

Amidst the overhang and risks of subsidy sharing, stocks of all public sector (PSU) oil and gas companies have seen sharp cuts. GAIL, too, fell about 12 per cent in October, before seeing some rebound over the past two days.

While the Centre has not indicated any move to push PSU oil firms to share subsidies, Nilesh Ghughe at HDFC securities says that if it does, GAIL stands to be the last in the pecking order, while ONGC/OIL India would be the first to share the subsidy burden, followed by oil marketing companies. Hence, the risk for GAIL is least. Moreover, on the earnings front, there are multiple triggers. Higher crude oil prices support GAIL’s earnings by way of higher realisation in the petrochemicals business, and higher trading margins.

Foreign brokerage CLSA recently said GAIL is their preferred play on higher crude prices (along with ONGC and Vedanta), given this may raise spreads in its LPG production business and could also mean higher LNG trading margins.

From the second half of FY19, spot crude prices and rupee may raise GAIL’s FY19/20 earnings estimate by 10-14 per cent, says CLSA, as the brokerage did not foresee any subsidy burden on the firm.

Further, though the decision on a unified tariff is still awaited, the regulator recently decided on tariff hike in four of GAIL’s pipelines. The most important Dahej-Uran-Panvel-Dabhol pipeline (DUPL-DPPL), which transmits about 13 per cent of GAIL’s current volumes, saw 54 per cent increase in tariff, while the other three small pipelines have seen 161- 691 per cent increases.

Analysts at ICICI Securities have, thereby, increased their tariff estimates by 5.6 per cent from H2FY19, and upgraded their FY20 earnings estimates by about 4 per cent.

The company is also benefitting from rising natural gas prices, thereby reducing concerns regarding higher prices of US and Russian natural gas contracts. Concerns had been raised earlier on placement of these take-or-pay contracts. Now, rising global prices means better placement opportunity.

GAIL will be spending 78 per cent of its overall planned capex of Rs 118 billion over FY19-20 on new pipelines. This will help it capitalise on gains from the rising industrial gas demand, city distribution, and automobile demand. Inclusion of natural gas in GST could add more to benefits, given it will make natural gas cheaper by 12-18 per cent (versus 6-13 per cent cheaper now) than fuel oil.