Gail (India) Ltd (GAIL) 305

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1 Result Update Rating matrix Rating : Buy Target : 355 Target Period : months Potential Upside : 16% What s changed? Target Changed from 390 to 355 EPS FY16E Changed from 17.2 to 14.2 EPS FY17E Changed from 20.8 to 18.6 Rating Changed from Hold to Buy Quarterly performance Q2FY16 Q2FY15 YoY (%) Q1FY16 QoQ (%) Revenue 14, , , EBITDA , , EBITDA (%) bps bps PAT , Key financials Crore FY14 FY15 FY16E FY17E Revenues 57, , , ,811.3 EBITDA 6, , , ,651.3 Net Profit 4, , , ,360.2 EPS ( ) Valuation summary FY14 FY15 FY16E FY17E P/E Target P/E EV / EBITDA P/BV RoNW (%) RoCE (%) Stock data Particular Amount Market Capitalization ( Crore) 38,688.6 Total Debt (FY15) ( Crore) 9,335.9 Cash and Investments (FY15) ( Crore) EV ( Crore) 47, week H/L 535/260 Equity capital ( Crore) 1,268.5 Face value ( ) 10.0 Price performance Return % 1M 3M 6M 12M GAIL 4.7 (13.3) (14.8) (38.5) Petronet LNG Gujarat Gas 9.9 (28.0) (24.7) 9.8 GSPL 7.8 (1.6) Research Analyst Mayur Matani mayur.matani@icicisecurities.com Harshal Mehta harshal.mehta@icicisecurities.com Passing through difficult times... November 4, 2015 Gail (India) Ltd (GAIL) 305 Gail reported its Q2FY16 results with revenues staying flat YoY at crore, above our estimates, mainly on account of higher than estimated gas marketing revenues EBITDA at crore came in below our estimate of crore as the natural gas trading, petrochemicals, LPG & other LHC segment reported lower-than-expected EBIT. However, the gas transmission profitability increased to crore against our expectation of crore (one off income of ~ 180 crore). Subsequently, PAT declined 66.2% YoY to crore (our estimate: crore) There was no subsidy burden on LPG for the quarter, as the company has not received any order from the Ministry of Petroleum & Natural Gas Gas transmission, trading business reports stable performance Natural gas transmission volumes increased 2.9% QoQ at 90 mmscmd in Q2FY16 against 87.5 mmscmd in Q1FY16. The pooling for power sector has primarily contributed to incremental volumes in the gas marketing and transmission volumes QoQ by 5.6 mmscmd and 1.9 mmscmd, respectively. Going forward, we expect incremental Gail volumes from gas pooling to power sector. We expect transmission volumes at 92.1 mmscmd and mmscmd for FY16E & FY17E, respectively. The gas trading segment reported EBIT of crore (estimates crore) vs crore QoQ on account of one time provision of 149 crore to the differentials in APM and non-apm prices, adjusted retrospectively. We expect gas trading EBIT to normalise from next quarter onwards. Petrochemicals business reports losses In the petchem business, volumes for Q2FY16 came at 84 KTPA vs. 50 KTPA in Q1FY16. The petchem EBIT loss came in at crore against our expectation of loss of 119 crore, on account of low utilisation of the existing capacity due to gradual commissioning activities of the incremental capacity. Higher raw material costs also contributed to the subdued petchem performance. Going forward, we expect petchem realisations to remain subdued due to lower crude oil prices. Although, higher use of spot gas would lead to the decline in costs, the EBIT of petchem segment would continue to remain subdued. The LPG/LHC segment reported EBIT of 72.1 crore in Q2FY16, lower than our estimates mainly on account of shutdown at ONGC Hazira plant. Going forward, profitability from the LPG/LHC segment will remain dependent on subsidy, domestic gas and LPG prices. We have assumed subsidy of 500 crore each for FY16E and FY17E as clarity on subsidy is awaited. Global oil prices, government policies key to future performance The decline in crude oil prices has led to lower expected realisations from the petchem and LPG business and is a key risk to the future profitability. However, domestic gas allocation priority to petchem & LPG business and complete clarification regarding abolition in subsidy burden borne by Gail s LPG business would be growth drivers for Gail. Higher gas transmission tariffs due to recent PNGRB s draft amendment pertaining to calculation of tariffs and growing CGD space, restoring gas volumes to higher levels would be other positive triggers for the company. We have valued the company using the SOTP methodology, valuing the core business using DCF and assigning a target multiple to the EBITDA of other business segments. We recommend BUY on GAIL due to sharp fall in stock price with a target price of 355. ICICI Securities Ltd Retail Equity Research

2 Variance analysis Q2FY16 Q2FY16E Q2FY15 YoY (%) Q1FY16 QoQ (%) Comments Higher than estimated on account of higher than estimated gas Total Revenues 14, , , , marketing and trading revenues Raw materials costs 11, , , , Employees Cost Other Expenses 1, , , Total Expenditure 13, , , , EBITDA , , , EBITDA was below our estimate on account of loss from petrochemical segment, lower than estimated LPG & other LLC and lower gas trading profitabilty EBITDA margins (%) bps bps Depreciation EBIT , Interest Other Income Increase in other income due to higher dividend income of 163 crore Extra Ordinary Item NA 0.0 NA PBT , , Total Tax PAT , Key Metrics Exchange rate ( /$) GAIL subsidy burden ( cr) NA 0.0 NA The company did not bear any subsidy burden during the quarter Transmn vol (mmscmd) Transmn realisatn ( /tscm) Trading Vol (mmscmd) Gas pooling by power sector contributed to higher trading volumes Trading realisatn($/mmbtu) Petchem Vol (000' tonnes) Petchem realisatn( /tonne) LPG/OLH vol (000' tonnes) LPG/OLH realisatn( /tonne) Low utilization of existing petchem capacity due to commisioning activities of incremental capacity, led to lower than estimated volumes Lower than estimated volumes mainly due to shutdown at ONGC Hazira plant. Change in estimates FY16E FY17E ( Crore) Old New % Change Old New % Change Comments Revenue 55, , , , Increased gas trading volumes than earlier estimates Continued loss estimate in Petchem segment and lower than estimated EBITDA 4, , , , EBITDA Margin (%) bps bps PAT 2, , , , EPS ( ) profit from LPG segment due to lower oil prices to impact EBITDA Assumptions FY14 FY15 FY16E FY17E FY16E FY17E Comments Exchange rate ( /$) GAIL subsidy burden ( cr) 1, , Estimate subsidy burden at 500 crore Transmn vol (mmscmd) Transmn realisatn ( /tscm) 1, , , , ,150.0 Trading Vol (mmscmd) Increased estimates due to higher incremental gas pooling volumes Trading realisatn($/mmbtu) Reduced due to lower spot LNG and domestic gas prices Petchem Vol (000' tonnes) Reduced estimates due to lower than expected gradual recovery in the existing petchem capacity Petchem realisatn( /tonne) 102, , , , , ,823.6 LPG/OLH vol (000' tonnes) 1, , , , , ,300.0 LPG/OLH realisatn( /tonne) 41, , , , , ,323.8 Decrease in crude oil prices to impact to LPG/OLH segment Current Earlier ICICI Securities Ltd Retail Equity Research Page 2

3 Company Analysis Volume outlook Natural gas transmission volumes increased 2.9% QoQ at 90 mmscmd in Q2FY16 against 87.5 mmscmd in Q1FY16. The pooling for power sector has primarily contributed to the incremental volumes in the gas marketing and transmission volumes QoQ by 5.6 mmscmd and 1.9 mmscmd respectively. Going forward, we expect incremental Gail volumes from gas pooling to power sector. We expect transmission volumes at 92.1 mmscmd and mmscmd for FY16E & FY17E, respectively. On the Kochi-Mangalore-Bangalore pipeline front, work has been initiated on multiple fronts and the negotiations with the farmers are currently progressing at 2 km/day along the 500 km stretch of Kochi-Mangalore pipeline and ROU has been signed along 250 km of the tract, with the help of the state government. Current issue pertains to the two districts, while other five of the overall seven districts have been taken onboard. Once a positive verdict comes from the Supreme Court, it will take ~18 months to complete and about six months to mobilise the resources for the Kochi-Bangalore leg of the pipeline. The work on the Kochi-Mangalore leg of the pipeline will get completed in a similar duration. For the Jagdishpur Haldia pipeline, a survey has been carried out and the company is waiting for commitment of gas from Ministry of Fertiliser to take the process further. Exhibit 1: Transmission volumes trend mmscmd FY13 FY14 FY15 FY16E FY17E ICICI Securities Ltd Retail Equity Research Page 3

4 In the gas trading business, out of the 8.3 mmtpa (US-5.8 mmtpa; Russia- Gazprom-2.5 mmtpa) long term contract signed, ~6 mmtpa will be sold domestically while ~1 mmtpa will be sold in the international market via GGSPL Singapore. With majority of the long term gas linked to Henry Hub and the company considering swapping of gas, the landed cost of gas in India will come down, which will lead to better volumes in the long term. The gas trading segment reported EBIT of crore (expectation of crore) from a EBIT of crore in Q1FY16 on account of a one time provision of 149 crore to the differentials in APM and non-apm prices, adjusted retrospectively. We expect gas trading EBIT to normalise from next quarter onwards. Exhibit 2: Gas trading volumes trend mmscmd FY13 FY14 FY15 FY16E FY17E Petrochemicals business reports losses In the petchem business, volumes for Q2FY16 came in at 84 KTPA vs. 50 KTPA in Q1FY16. The petchem EBIT loss came in at crore against our expectation of loss of 119 crore, on account of low utilisation of the existing capacity due to gradual commissioning activities of the incremental capacity. Higher raw material costs also contributed to the subdued petchem performance. Going forward, we expect petchem realisations to remain subdued due to lower crude oil prices. Although, higher use of spot gas would lead to the decline in costs, the EBIT of petchem segment would continue to remain subdued. The EBIT loss of the petrochem business is expected at crore in FY17E. Exhibit 3: Gail's EBIT break-up ( crore) FY13 FY14 FY15 FY16E FY17E Natural Gas transmission LPG transmission Natural Gas Trading Petrochemicals LPG and Liquid Hydrocarbons Gailtel Others EBIT ICICI Securities Ltd Retail Equity Research Page 4

5 Exhibit 4: Gail's EBIT break-up (%) FY13 FY14 FY15 FY16E FY17E Natural Gas LPG Natural Gas Trading Petrochemicals LPG and Liquid Hydrocarbons Gailtel Others Total The LPG/LHC segment reported EBIT of 72.1 crore in Q2FY16, lower than our estimates mainly on account of shutdown at ONGC Hazira plant. Going forward, profitability from the LPG/LHC segment will remain dependent on subsidy sharing, domestic gas prices and global LPG prices. We have assumed subsidy of 500 crore each for FY16E and FY17E as clarity on subsidy is awaited. The share of the LPG/LHC business in Gail s EBIT is expected at 14.2% and 19.1% in FY16E and FY17E, respectively. The EBIT of the LPG, LHC business is expected at crore and crore in FY16E and FY17E, respectively. However, the benefits of lower subsidy and decline in domestic gas prices may get negated in case of lower than estimated LPG realisations. Exhibit 5: Gail s subsidy sharing Crore FY13 FY14 FY15 FY16E FY17E ICICI Securities Ltd Retail Equity Research Page 5

6 Outlook & Valuation The decline in crude oil prices has led to lower expected realisations from the petchem and LPG business and is a key risk to the future profitability. However, domestic gas allocation priority to petchem & LPG business and complete clarification regarding abolition in subsidy burden borne by Gail s LPG business would be growth drivers for Gail. Higher gas transmission tariffs due to recent PNGRB s draft amendment pertaining to calculation of tariffs and growing CGD space, restoring gas volumes to higher levels would be other positive triggers for the company. We have valued the company using the SOTP methodology, valuing the core business using DCF and assigning a target multiple to the EBITDA of other business segments. We recommend BUY on GAIL due to sharp fall in stock price with a target price of 355. Exhibit 6: Valuation Segments Enterprise Value ( Crore) per share % of SOTP Method Transmission Business Natural Gas Transmission DCF LPG Transmission DCF Value of transmission business Other Businesses Natural Gas Trading x FY17E EV/EBITDA Petrochemicals x FY17E EV/EBITDA LPG and Liquid Hydrocarbons x FY17E EV/EBITDA Value of Other Businesses Investments Quoted % discount to CMP Unquoted Value of Investments Firm Value Less: Net Debt Equity Value Source: ICICIdirect.com Research Exhibit 7: Valuation matrix Year Sales Sales Gr. EPS EPS Gr. PE RoNW ( Crore) (%) ( ) (%) (x) EV/EBITDA (x) (%) RoCE (%) FY14 57, FY FY16E 55,486.0 (2.2) 14.2 (40.5) FY17E ICICI Securities Ltd Retail Equity Research Page 6

7 Company snapshot Target Price: Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Source: Bloomberg, Company, ICICIdirect.com Research Key events Date Event Mar-09 Gail declares gas transmission volume target for the next fiscal year and announces aggressive capex plans over the next 3-4 years. Reliance KG basin also set to begin production in April Apr-10 PNGRB fixes tariffs for Gail's HVJ pipeline, which was in line with market expectations. That brought clarity on Gail's transmission tariffs May-10 Government allowed Gail to charge marketing margin on administered price mechanism (APM) gas Jan-11 Results for Q3FY11 were below market expectation on account of lower-than-expected profitability from petchem and LPG /liquid hydrocarbon segment Jul-11 Declares Q1FY12 results. It disappoints on the gas transmission volume front and future uncertainty about production from Reliance KG basin May-12 Volumes from Reliance KG basin continue to decline. Also, higher subsidy sharing burden continue to impacts profitability of the company Jan-13 The Rangarajan committee submitted its report to the Prime Minister s Office (PMO) on fiscal terms under the PSC, gas pricing, contract management and audit, which if implemented would be positive for the sector. It also recommended that Gail should be excluded from the subsidy sharing mechanism Jun-13 Government of India announces increase in gas prices based on the Rangarajan committee recommendations Oct-13 Government caps subsidy burden for FY14 at 1400 crore May-14 Government increases Gail subsidy burden for FY14 to 1900 crore and results disappoint Oct-14 Government announces gas pricing policy Dec-14 Sharp fall in the crude oil prices, which would negatively impact its LPG and petrochemical segment, leading to a decline in the stock price Top 10 Shareholders Rank Name Latest Filing Date % O/S Position (m) Change (m) 1 Government of India 30-Jun Life Insurance Corporation of India 30/Jun/ Oil and Natural Gas Corporation Ltd 30-Jun Indian Oil Corpn Ltd 30/Jun/ Matthews International Capital Management, L.L.C. 30-Jun Fidelity Management & Research Company 30/Sep/ Aberdeen Asset Management (Asia) Ltd. 31-Aug Norges Bank Investment Management (NBIM) 31/Dec/ BlackRock Institutional Trust Company, N.A. 30-Sep The Vanguard Group, Inc. 30/Sep/ Source: Reuters, ICICIdirect.com Research Shareholding Pattern (in %) Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Promoter FII DII Others Recent Activity Investor name Investor name Investor name Value Shares Investor name Value Shares Life Insurance Corporation of India 46.63m 7.56m Fidelity Management & Research Company m -4.75m Matthews International Capital Management, L.L.C m 2.04m T. Rowe Price Associates, Inc m -3.16m Hermes Investment Management Ltd m 2.02m Franklin Advisers, Inc m -1.90m DSP BlackRock Investment Managers Pvt. Ltd m 1.67m Mellon Capital Management Corporation -8.21m -1.58m Norges Bank Investment Management (NBIM) 7.70m 1.46m T. Rowe Price Hong Kong Limited -7.30m -1.16m Source: Reuters, ICICIdirect.com Research ICICI Securities Ltd Retail Equity Research Page 7

8 Financial summary Profit and loss statement Crore (Year-end March) FY14 FY15 FY16E FY17E Revenue 57, , , ,811.3 Growth (%) (Inc.) / Dec stock in trade Raw material Costs Purchase of trading goods Employee Costs Other Expenditure Op. Expenditure EBITDA 6, , , ,651.3 Growth (%) Depreciation EBIT Interest Other Income PBT Growth (%) Tax Reported PAT 4, , , ,360.2 Growth (%) EPS Cash flow statement Crore (Year-end March) FY14 FY15 FY16E FY17E Profit after Tax 4, , , ,360.2 Less: Dividend Paid 1, Add: Depreciation 1, , ,388.9 Add: Others Cash Profit 4, , , ,014.7 Increase/(Decrease) in CL 1, ,469.9 (Increase)/Decrease in CA -1, , ,241.3 CF from Operating Activities Purchase of Fixed Assets 4, , , ,043.0 (Inc)/Dec in Investments -1, , Others CF from Investing Activities -6, , ,443.0 Inc/(Dec) in Loan Funds 1, Inc/(Dec) in Sh. Cap. & Res Others CF from financing activities 1, Change in cash Eq Op. Cash and cash Eq , Cl. Cash and cash Eq , ,089.1 Balance sheet Crore (Year-end March) FY14 FY15 FY16E FY17E Source of Funds Equity Capital 1, , , ,268.5 Preference capital Reserves & Surplus 25, , , ,404.9 Shareholder's Fund 27, , , ,673.4 Loan Funds 9, , , ,115.9 Deferred Tax Liability 2, , , ,608.7 Minority Interest Source of Funds 39, , , ,397.9 Application of Funds Gross Block 34, , , ,389.3 Less: Acc. Depreciation 12, , , ,305.3 Net Block 21, , , ,084.0 Capital WIP 9, , ,803.0 Total Fixed Assets 31, , , ,887.0 Investments 7, , , ,122.3 Inventories 2, , , ,639.3 Debtor 2, , , ,770.5 Cash , ,089.1 Loan & Advance, Other CA 6, , , ,633.9 Total Current assets 11, , , ,132.9 Current Liabilities 8, , , ,311.4 Provisions 1, , , ,432.8 Total CL and Provisions 10, , , ,744.2 Net Working Capital , , ,388.6 Miscellaneous expense Application of Funds 39, , , ,397.9 Key ratios (Year-end March) FY14 FY15 FY16E FY17E Per share data ( ) Book Value Cash per share EPS Cash EPS DPS Profitability & Operating Ratios EBITDA Margin (%) PAT Margin (%) Fixed Asset Turnover (x) Inventory Turnover (Days) Debtor (Days) Current Liabilities (Days) Return Ratios (%) RoE RoCE RoIC Valuation Ratios (x) PE Price to Book Value EV/EBITDA EV/Sales Leverage & Solvency Ratios Debt to equity (x) Interest Coverage (x) Debt to EBITDA (x) Current Ratio Quick ratio ICICI Securities Ltd Retail Equity Research Page 8

9 ICICIdirect.com coverage universe (Oil & Gas) CMP M Cap EPS ( ) P/E (x) EV/EBITDA (x) RoCE (%) RoE (%) Sector / Company ( ) TP( ) Rating ( Cr) FY15 FY16E FY17E FY15 FY16E FY17E FY15 FY16E FY17E FY15 FY16E FY17E FY15 FY16E FY17E Aban Offshore (ABALLO) Hold 1, Cairn India (CAIIND) Hold 29, GAIL (India) (GAIL) Buy 38, Gujarat Gas (GUJGAS) Hold 7, Gulf Oil Lubricants (GULO) Hold 2, Hindustan Petroleum (HINPET) Hold 26, Indian Oil Corporation (INDOIL) Hold 97, Indraprastha Gas (INDGAS) Buy 6, Mangalore Refinery (MRPL) Buy 10, Oil India Limited (OILIND) Buy 24, ONGC (ONGC) Hold 213, Petronet LNG (PETLNG) Buy 14, ICICI Securities Ltd Retail Equity Research Page 9

10 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Strong Buy: >15%/20% for large caps/midcaps, respectively, with high conviction; Buy: >10%/15% for large caps/midcaps, respectively; Hold: Up to +/-10%; Sell: -10% or more; Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai research@icicidirect.com ICICI Securities Ltd Retail Equity Research Page 10

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