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MOSL : GAIL: Strong showing by the Gas Trading segment; supply from Gazprom remains a concern in 2QFY23

.  GAIL: Strong showing by the Gas Trading segment; supply from Gazprom remains a concern in 2QFY23

(GAIL IN, Mkt Cap USD7.7b, CMP INR140, TP INR176, 26% Upside, Buy)

• GAIL reported a 31%/33% beat on EBITDA/PAT in 1QFY23 as strong gains in the Trading business offset other weak segments. Operating performance in the Transmission and Petrochemicals segment decreased on a YoY and QoQ basis.
• Gazprom triggered the force majeure clause on ~2.5mmt of volume (~14mmt of its total LNG portfolio), which will ultimately mean higher gas prices. As a few consumers may not be able to afford higher gas prices, it may result in slightly lower offtake till the time the situation persists.
• While Gas Trading volumes remained strong in 1Q (up 5% YoY), this segment will remain soft in 2Q FY23, led by loss of volumes due to supply issues from Gazprom. Commissioning of the new fertilizer plant at Sindri, Barauni, and Gorakhpur will boost demand and aid profitability from CY23.
• Gas Transmission volumes grew 2% each YoY and QoQ to 109mmscmd in 1QFY23. The management expects volumes of ~120mmscmd, once the fertilizer plants run at full utilization. The Transmission business is expected to grow at 8-10% CAGR over the next three years.
• Utilization of their petchem plant fell to 83% in 1QFY23 from 111% in 4QFY22. The management expects utilization to remain muted in 2HCY22 till supply from Gazprom is fulfilled. Petchem margin for PE/PP/PVC fell 4%/9%/31% QoQ in 1QFY23, but is likely to improve in the near term.
• The 10MW hydrogen plant in Madhya Pradesh will be fully commissioned over the next 18 months. The management has guided at a capacity of 35MW by CY30.
• Factoring all of these, we have revised our Gas Trading volumes to 100/ 120mmscmd and thus increase GAIL’S EBITDA by 15%/4% in FY23/FY24. We value the core business at 8x FY24E adjusted EPS of INR17.8. Adding the value of listed and unlisted investments of INR32, we arrive at our TP of INR176/share.

Gains in the Trading business offset by other weak businesses

• EBITDA came in 31% ahead of our estimate at INR43.6b (up 81% YoY and 18% QoQ) due to a strong performance by the Gas Trading segment.
• PAT grew 91% YoY and 12% QoQ to INR29.1b (33% ahead of our estimate), translating into an EPS of INR6.5 (est. INR4.9).

Segmental EBIT details for 1QFY23:

• EBIT from the Gas/LPG Transmission business stood at INR8b/INR0.8b, down 13%/3% YoY.
• EBIT for the Trading business grew by ~6x YoY to INR23.1b.
• Petchem EBIT stood at INR0.3b, down 75% YoY and 91% QoQ.
• LPG and HC EBIT was lower than our estimate at INR6.3b (flat YoY, but down 13% QoQ).

Valuation and view; Buy

• The management expects higher demand from the commissioning of fertilizer plants, ongoing refinery and petchem expansions, and the development of CGDs.
• It has guided at a capex of ~INR75b in FY23. GAIL is executing various projects worth INR300b, spread over the next three years.
• Utilization from the company’s Urja Ganga pipeline will touch 60-75% by the end of FY23. Petchem expansion at the PATA and Usar plants is on schedule (contract and licensing work have already been completed).
• The stock trades at a discount of ~39% to its one-year forward long-term P/E average. Valuing the core business at 8x FY24 adjusted EPS of INR17.8 and adding the value of listed and unlisted investments of INR32, we arrive at our TP of INR176/share. We maintain our Buy rating on the stock. GAIL remains our top pick in the sector.