Company update: GAIL (Outperformer) - Concerns receding; attractively priced

The 11% underperformance in GAIL’s stock price (last 6M) has been driven by multiple concerns – the impact of US LNG cargoes on the trading segment, rumours on unbundling and slow progress on stabilization of new capacity in the petchem segment. With 1) the PNGRB chairman clearing the air on unbundling in recent interactions (not likely to happen), 2) Alleviating price differential between spot and term LNG (higher) and US LNG (in favour of the latter), 3) imminent inclusion of gas in GST, 4) news of aggressive bidding of GAIL in the new City Gas Distribution (CGD) round and 5) management’s guidance on healthy utilisation of petchem capacity, we see very little reason for valuations to persist at current levels of 12.6x FY20E EPS/ 7.4x EV/EBITDA. We see solid near-term prospects, with expected profitability in Q1FY19, which would benefit from stronger HDPE and steady LPG prices. Reiterating Outperformer with a target price of Rs435.

Concerns being laid to rest, one step at a time: GAIL has seen a surfeit of good news over last 2 months. Reported statements from PNGRB imply that unbundling of GAIL is currently on the backburner and the price differential between US LNG and Asian LNG has been turning in favour of US LNG in recent months. Additionally, recent news on GST inclusion and aggressive bidding in the CGD auction are positive triggers for GAIL.

Q1FY19 to see stellar performance: Apart from improving structural factors across businesses, near term prospects too look attractive. We believe higher PE, steady LPG prices coupled with some increase in gas and petchem volumes should help deliver strong growth in profitability yoy for the quarter. We estimate a 37% yoy and 21% qoq growth in PAT to Rs12.6bn in Q1FY19, implying a strong FY19E for GAIL.

Valuations attractive; reiterate Outperformer: GAIL trades at an attractive 12.6x FY20E EPS (10.2x excluding investment value of Rs69/sh) and 1.7x FY20E P/B, which underplays the 23% earnings CAGR over FY18-20E and 310/350 bps improvement in RoE/RoCE over FY18-20E, respectively. GAIL trades at the midpoint of 5 year-PE/PBV bands and we expect the company’s multiples to see a steady rerating over the next 18-24 months. A higher-than-estimated (15%) increase in tariff and more than 8-9% annual growth in gas demand are upside risks to our estimates. We reiterate Outperformer with a target price of Rs435/sh (13x FY20E EPS of Rs28.2 + investments@20% discount to CMP valued at Rs69/sh), implying 22% upside from CMP.