GAIL’s Valuations remain overly pessimistic and ignore the solid business model and strong long-term prospects: ICICI Securities

Gazprom supply constraints to persist over the next 12 months

We met the senior management of GAIL (CGM, F&A) on Dec 16, 2022 for an update on business and the outlook ahead. Key takeaways:

► No resolution of Gazprom supply disruption: Gazprom’s gas supply to GAIL as a part of long term 2.4mtpa LNG contract was paused from May 2022 and has not been reinstated. GAIL has tried to mitigate this shortfall of 8-9mmscmd by cutting down supplies to fertiliser and power sectors and also reducing utilisation of its own Pata Petrochemical plant (in Uttar Pradesh) to <40%. There are still some customer contracts that it had to fulfill due to supply or pay obligation (to the extent of 1- 1.5mmscmd) which it had done via spot LNG. Going forward, some additional volumes from domestic sources (RIL, ONGC, Cairn) will help improve overall transmission volumes. But for rest of FY23E and H1FY24E, the shortfall is likely to persist and hence, we see transmission volumes persisting between 108- 109mmscmd in the near term. ► Regulatory environment has improved: In recent months, PNGRB has moved ahead on long-pending issues with respect to tariff and capex inclusions. A longer ramp-up for volumes (10 years vs 5 earlier), inclusion of ‘system use gas’ (SUG) @0.1%, 5-year exemption for capacity expansion from new gas sources and prospective tax rate will all be material positives for overall tariffs. Also, introduction of integrated tariffs will ease the pressure on customers at the farthest end of the network as they have to pay the cascading tariffs currently of all the pipelines that are used to transport the gas to them. On a blended basis, however, we see a material upside to transmission tariffs FY24E onwards.

► Gas trading and petrochemical to remain under pressure: Thanks to the disruption in Gazprom supply, GAIL is backstopping the supply gap by diverting all its cargoes to India. Resultant, it does not have any spare cargoes to leverage the spot LNG vs US HH differentials. Additionally, it has also cut the gas supply to its own petrochemical units at Pata and hence, utilisation of the same has reduced to ~40% and is likely to stay there for the next 6-9 months. The LPG segment remains relatively in good shape, and the imminent reduction of APM gas prices as per Kirit Parikh Committee should help ease margin pressures over FY24E.

► We cut EPS for FY23/24e, BUY recommendation stays: We revise FY23/24E EPS down by 10/9% respectively, to factor i) lower trading margins, ii) lower petrochemical volumes and iii) lower transmission volumes. This is offset partially by 5% higher transmission tariffs assumed for FY24e onwards, albeit there is an upside risk to this estimate. Valuations of <7x FY24E EPS and just 5.3x EV/EBITDA remain overly pessimistic and ignore the solid business model and strong long-term prospects. Reiterate BUY with a revised TP of Rs127 (earlier TP 137). We value GAIL on the basis of FY24E EV/EBITDA multiples of 4-5.5x applied to various segments, leading to a target price of Rs127/sh (implying 30% upside). Current valuations of 6.3x FY24E EPS and 5.3x FY24E EV/EBITDA remain well below 5-year valuation bands. Even at our target price, P/E of 8.2x FY24E EPS, and EV/EBITDA at 4.7x FY24E, are below peak valuations. Reiterate BUY.