GAIL (India) Ltd is on its way to becoming a true utilities company—gas transmission will account for over 65% by FY14 from 53% in FY09 of its earnings before interest and tax (Ebit).
Its transmission business has all the characteristics of a utilities company—large asset base with annuity like returns, secular demand growth with strong long-term earnings visibility and direct customer interface with city gas distribution (CGD) business. We believe that GAIL should trade on a par with other utility companies.
India is witnessing a big thrust in gas production from domestic finds in the Krishna-Godavari basin. We expect gas availability in India to grow at 23% compounded annual growth rate (CAGR) to 312 million standard cu. m per day (mscmd) by FY14, buoyed by trebling of domestic production to 254 mscmd and doubling of regasified liquefied natural gas imports to 58 mscmd. To capture the huge transmission opportunity presented by this gas surge, GAIL is investing to double its capacity by FY12-13. We expect its transmission volumes to grow at 20% CAGR through FY14 to 208 mscmd.
Against consensus expectations of tariff decline for its Hazira-Vijaipur-Jagdishpur (HVJ) and Dahej-Vijaipur (DVPL) network (which accounts for more than 65% of its total volumes), our calculations indicate that tariffs should stay intact or even increase by 10%. We expect GAIL’s profits (Ebit) from the transmission business to increase 2.8x by FY14.
Also See | Planned Pipeline Network (Graphics)
To capture the opportunity presented by the impending gas surge in India, GAIL is investing significantly in its pipeline network. Over the next three years, it will invest Rs3,000-3,500 crore, expanding its transmission capacity from the current 150 mscmd to 300 mscmd.
Its major pipeline projects include: upgradation/extension of HVJ-GREP network, Jagdishpur-Haldia pipeline, Dabhol-Bangalore pipeline, and Kochi-Mangalore-Bangalore pipeline. The three new cross-country pipelines are likely to be completed only in FY13.
The capacity augmentation of HVJ-DVPL pipeline is underway. The expansion on the trunk line by laying the Bawana-Nangal pipeline, the Chainsa-Jajjar-Hissar pipeline, and the addition of compressors at its various stations would increase the total HVJ-DVPL network capacity to 78 mscmd.
GAIL is also expanding its CGD presence from the current nine cities to 45-50 cities in the next 4-5 years with a gas volume potential of 25 mscmd. We believe CGD would lead to long-term value creation for GAIL and just 25 mscmd volumes would add Rs27 per share. Further value accretion would come from its exploration and production (E&P) blocks entering production phase and doubling of petrochemical capacity by FY12.
Hence, we remain positive on GAIL primarily due to long-term revenue visibility, value creation through the CGD business, potential upside from its E&P business, and likely favourable policy decision on subsidy. We value GAIL on sum-of-the-parts basis at Rs485 and believe there is further upside potential of at least Rs27 per share from its CGD business. Adjusted for investments, the stock trades at 11.7x estimated FY12 earnings per share of Rs29.10. We maintain buy.
Graphics by Ahmed Raza Khan/Mint