The ugly truth India faces today is that domestic gas supplies are frighteningly inadequate. Given the unpleasant situation, GAIL (India) Ltd’s strategy to tie up long-term gas supplies is definitely a smart thing to do.
The company announced on Monday that it signed an agreement to book annual 2.3 million tonnes liquefaction capacity at the Cove Point LNG liquefaction terminal in the US. Under the deal, GAIL will procure its own natural gas and deliver it to the Cove Point pipeline for liquefaction at the terminal.
This agreement will improve GAIL’s scale of operations in the US where the company already has a presence. According to the company’s press statement, “This deal would also provide GAIL with an opportunity to trade part of the volume in the international market apart from organizing the ships required to transport rest of the volume to India.” While the development is positive, the problem is that this is a bit too long term for investors to start discounting in their numbers. Construction work on the terminal is expected to start in 2014 and liquefaction facilities are anticipated to kick off in 2017. Perhaps that’s why investors have not really reacted dramatically to this news flow.
From the short-term perspective, there are some issues. The obvious one is the domestic shortage of gas supplies and its impact on the GAIL’s transmission business. The company’s transmission volumes have continuously fallen in the last few quarters. For the quarter ended December, transmission volumes stood at the lowest in the past five quarters at that time.
Another concern is the possible increase in the domestic gas prices that the government is contemplating. An increase in gas price is expected to have an adverse impact on GAIL’s financials. “Assuming it is not able to pass on any cost increase (or reduce gas costs by increasing Panna-Mukta and Tapti volumes for its own consumption), we see an impact of 15-16% to our FY14F/15F EPS (earnings per share) estimates,” wrote Nomura Equity Research analysts in a note on Tuesday.
The GAIL stock has underperformed the benchmark Sensex in the last fiscal year and currently trades at about 10 times its estimated earnings for FY14. That is not too high, but with few triggers in the foreseeable future, sentiments are likely to be muted for some more time. Investors would do well to keep a tab on the subsidy numbers for the March quarter.