Management Speak: GAIL (Outperformer) - Ignore the overhang, focus on fundamentals
Presented is the gist of our meeting with GAIL’s management:
Any accounting separation short of full unbundling will not impact business strength: GAIL’s management affirmed that the company maintains a detailed and separate record of each business segment. Hence, if asked to, it could segregate the petchem segment and list it as a subsidiary, with no impact on gas sales to the segment from its trading arm. Therefore, fear of synergies between the segments being lost due to different accounting treatments and separation are exaggerated.
Business fundamentals remain strong: Steady growth in gas transmission/trading volumes (IDFCe 4/9% CAGR in transmission/trading volumes over FY18-20E), improving petchem utilisation, strong LPG margin trends and imminent tariff order for its transmission pipelines combined, are expected to deliver material improvement in profitability over FY18-20E. GAIL would be shut-down for 20-25 days in October to streamline pending technical issues at the new Pata II plant. Management has guided in excess of 100% capacity utilization for overall capacity in FY20E, i.e., > 810kt (IDFCE 800ktpa).
US LNG shifts from key concern to an earnings driver: The trading segment reported highest EBIT of Rs5.5bn in Q1FY19 - highest in 4 years (3.5x qoq, 64% yoy growth). We attribute this to the favourable price differential between crude-linked spot LNG and US Henry Hub (HH)-linked LNG - the highest in 2 years, which drove trading gains on GAIL’s un-hedged portion of 5.8mt US LNG portfolios.
Eastern pipeline on track; Kochi-Mangalore completion by Q4FY19E/Q1FY20E: The Kochi Mangalore pipeline is expected to be completed by March-April 2019 despite delays, while all phases of Urja Ganga are on track and due for completion by Dec 2020E. Additionally, GAIL’s capex is slated to exceed Rs175bn over next 3 years (Rs89bn over FY15-18), to meet higher pipeline expansion + CGD capex.
Valuations & View: Growth in each segment (gas transmission /trading/petchem and LPG), coupled with healthy margins and moderate input costs would drive 22% EPS (22% in valuations para?) CAGR over FY18-20E, with ROE/ROCE expected to improve 290bps/340bps over the period. Current valuations of 10.7x FY20E EPS (net of investment value of Rs72/sh) do not reflect these strengths, making these levels attractive to Buy. Reiterate Outperformer with a target price of Rs435.
Gail India is engaged in the natural gas, liquified natural gas ("LPG"), liquid hydrocarbons and petrochemicals exploration and production and city gas distribution through its natural gas trunk pipelines covering a length of around 7000 km and over 1900 km of LPG pipeline transmission network. Co. is also engaged in the telecom business with the network of approx. 13,000 km throughout India. Co. operates six primary business segments: Transmission Services, Natural Gas Trading, Petrochemicals, LPG and other Liquid Hydrocarbons, GAILTEL and City Gas Distribution.
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