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GAIL: Gas goes for a toss!
Jan 12, 2006

Performance summary
The performance of GAIL (Gas Authority of India Limited) in the third quarter of the fiscal year, despite lower subsidy share, is a mixed bag. While the growth at the topline level is impressive, profitability was hampered could be attributed to the loss in the natural gas trading business, even as the petrochemical margins were robust. However, the performance in the first nine months of the fiscal is relatively better.

(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net sales 34,751 44,455 27.9% 102,421 121,435 18.6%
Expenditure 24,509 35,344 44.2% 75,762 93,500 23.4%
Operating profit (EBDITA) 10,243 9,111 -11.1% 26,660 27,934 4.8%
EBDITA margin (%) 29.5% 20.5%   26.0% 23.0%  
Other income 1,395 1,519 8.9% 2,739 3,711 35.5%
Interest 307 406 32.5% 1,025 881 -14.1%
Depreciation 2,416 1,414 -41.5% 7,093 4,204 -40.7%
Profit before tax 8,914 8,809 -1.2% 21,281 26,561 24.8%
Tax 2,562 2,378 -7.2% 6,977 7,553 8.3%
Profit after tax/(loss) 6,353 6,432 1.2% 14,304 19,008 32.9%
Net profit margin (%) 18.3% 14.5%   14.0% 15.7%  
No. of shares (m) 845.7 845.7   845.7 845.7  
Diluted earnings per share (Rs)*         28.6  
Price to earnings ratio (x)         9.9  
(*trailing twelve months earnings)            

What is the company's business?
GAIL India is the country’s largest gas distribution and transmission company with a pipeline network of over 4,500 kms across the length and breadth of the country. The company’s HBJ pipeline is the lifeline for major gas consumers ranging from power and fertilizer sectors. GAIL accounts for nearly 95% of the gas business in the country. The company has also ventured into upstream gas exploration business and is a participant in the gigantic Myanmar gas fields, which are likely to commence production in 2007. Given the fact that GAIL is largely dependent on ONGC for its gas requirements, the exploration business holds prominence for the company.

What has driven performance in 3QFY06?
Volumes are robust: While natural gas trading division posted a 5% QoQ growth in sales, the petrochemicals and hydro-carbon divisions posted 14% and 30% QoQ growth in the third quarter. While favorable petrochemical prices have helped the company, better natural gas availability propped natural gas volumes. The natural gas transmission in 3QFY06 was 81.4 MMSCMD, which is 11% YoY growth. The petrochemical production was higher by 3% YoY and volume sales were higher by 9% over the same period last year.

Expenditure table…
(%) of sales 3QFY05 3QFY06
Raw materials 2,253 4,149
% sales 6.5% 9.3%
Purchases 20,072 27,787
% sales 57.8% 62.5%
Staff cost 481 612
% sales 1.4% 1.4%
Other expenditure 2,244 2,999
% sales 6.5% 6.7%
Change in stock (542) (203)
% sales -1.6% -0.5%

Trading business posts losses: The company's share of the subsidy in 3QFY06 was an estimated Rs 2,060 m (5% of sales as compared to 11% in the corresponding quarter in the previous year), which is lower by 44 YoY. The cumulative subsidy share for the nine months period of the current financial year was Rs 5,260 m (4% of sales) as against Rs 8,640 m (8% of sales) during the corresponding period of the last financial year. Despite the decline, operating margins have declined on account of significant increase in raw material cost. Also, the fact that LPG transmission during the quarter was 0.5 MMT, which was 10% lower due to shut down of Jamnagar Refinery and LPG production was also lower mainly due to low gas availability, had an impact on margins.

Lower depreciation charge prop up profits: While operating profits were lower by 11% in 3QFY06, PBT declined at a much lower rate owing to lower depreciation charges. This was due to the change in depreciation charges for its pipeline and related facilities to 3.2% from 10.3% (effective April 2005).

What to expect?
At Rs 282, the stock is trading at a price to earnings multiple of 9.9 times trailing twelve months earnings. While the impact of the Jamnagar refinery shutdown was a one-time effect, which in our view can be recovered in the next fiscal, lower gas availability continues to remain an area of concern for the company. In this context, one has to take a longer-term perspective considering the significant gas finds in the last three years by both the private and public sector oil majors. We believe that GAIL is in a very strong position (with its distribution network) to capitalise on the growth opportunity going forward. Not only transmission but considering the company's significant investments in many state-level distribution companies (CNG and piped natural gas), we believe that GAIL has a compelling case (Indraprastha Gas, Bhagyanagar Gas and more on the anvil).

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