Gail earnings prospects bright, but petchem biz a challenge
Gail (India) Ltd’s shares have rallied substantially in the past six months, gaining as much as 50%. Investors appear to be thrilled about the volume prospects of the state-run company’s gas transmission business amid robust demand.
There is also some optimism around the potential turnaround in the petrochemicals business, despite a loss at the Ebit level in the past four quarters.
But not everyone is convinced. Earlier this week, analysts at Kotak Institutional Equities downgraded Gail’s stock to ‘sell’ from ‘reduce.’
“As we noted last month, we believe that despite the recent strong gas consumption data, India’s medium-term gas demand outlook is weak and long-term outlook is even weaker,” said Kotak’s analysts in a report on 1 January. Despite weak profitability, Gail’s further large capex in petrochemicals (petchem) has been a key worry, they added.
As such, the recovery in the petchem business profitability is likely to be gradual. However, it does help that the Ebit loss of the petchem business narrowed sequentially in the September quarter (Q2FY24) aided by cost optimization measures. This factor, along with a huge beat in the gas trading business meant Gail’s profits surpassed market expectations in Q2.
The management is now confident about surpassing FY24 gas trading Ebitda guidance of ₹3500 crore, after the business clocked earnings of ₹2700 crore in the half-year ending September (H1FY24). This measure is expected to reach ₹4,000 crore in FY25.
In the gas transmission business, Gail expects volumes to be at 120 million standard cubic meters per day (mmscmd) in FY24 and rise to about 132 mmscmd for FY25. In FY23, transmission volume stood at 107 mmscmd.
The drop in international gas prices in tandem with strong demand and anticipated higher tariffs is likely to benefit the company. Further, the anticipated softness in global LNG prices due to the forthcoming commissioning of substantial capacities in the US and Qatar is expected to drive demand over the years. Notably, the rising demand for LNG helps boost Gail’s transmission business. Plus, the increasing availability of domestic gas from producers such as Reliance Industries Ltd, Oil & Natural Gas Corp. Ltd, and Oil India Ltd, also helps.
Against this backdrop, Motilal Oswal Financial Services anticipates that transmission Ebitda would account for 46% of total Ebitda in FY26, up from 40% in FY23. “This should improve the earnings stability,” said the Motilal report dated 28 December.
To expand the pipeline network, Gail has a capex plan of ₹3,600 crores for FY24. Total capex plan for FY24 stands at about ₹10,500 crore. Over the medium-term, Motilal Oswal’s analysts estimate Gail to report a free cash flow of ₹4,560 crore in FY26 (versus negative ₹4,530 crore in FY23) despite capex mounting 64% over FY24-26E (versus the average for FY19-23).
Meanwhile, Gail is actively assessing the monetization of its city gas distribution (CGD) assets. It aims to unlock substantial value from its investment in Gail Gas. Among other options, Gail may merge geographical areas with Gail Gas and list it. However, a weak demand outlook in the CGD sector raises concerns.
For now, the sharp appreciation in the stock suggests that investors are largely factoring in the positive development, potentially limiting future gains. Investors should watch out for improvement in return ratios, utilization rates and recovery in earnings of the petchem business.
