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GAIL: LNG matters

Jan 29, 2005

Performance Summary
GAIL India, the country's largest gas distribution and transmission company with a market share of nearly 95%, announced its 3QFY05 results yesterday. During the quarter, the company has witnessed a decent topline growth of over 20% YoY, while the bottomline has grown by an impressive 64% YoY. This performance could be attributed to the additional gas volumes made available to GAIL from Petronet LNG's terminal at Dahej.

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.

(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net sales 28,920 34,751 20.2% 86,865 100,034 15.2%
Expenditure 21,475 24,509 14.1% 63,990 73,374 14.7%
Operating profit (EBDITA) 7,445 10,243 37.6% 22,875 26,660 16.5%
EBDITA margin (%) 25.7% 29.5% 26.3% 26.7%
Other income 323 1,395 331.6% 1,680 2,739 63.0%
Interest 207 307 48.5% 1,051 1,025 -2.5%
Depreciation 1,658 2,416 45.7% 4,908 7,093 44.5%
Profit before tax 5,903 8,914 51.0% 18,597 21,281 14.4%
Tax 2,033 2,562 26.0% 6,205 6,977 12.4%
Profit after tax/(loss) 3,870 6,353 64.2% 12,392 14,304 15.4%
Net profit margin (%) 13.4% 18.3% 14.3% 14.3%
No. of shares (m) 845.7 845.7 845.7 845.7
Diluted earnings per share (Rs)* 18.3 30.0 19.5 22.6
Price to earnings ratio (x) 7.3 9.8
(* annualised)

What has driven performance in 3QFY05?
LNG helps boost revenues: During the current fiscal, the topline growth of over 20% YoY could be attributed to higher gas volumes given Petronet LNG's regasified natural gas made available to the company. It should be noted that GAIL contributes towards the subsidy-sharing scheme and during the quarter, the company's subsidy share during 3QFY05 was Rs 3.6 bn. But for this amount, the topline growth shows an improvement of nearly 23% YoY. Also contributing to the revenues were the company's other businesses such as LPG and petrochemicals (see table below).

3QFY04 3QFY05 (%) change
Natural gas 4,599.6 5,755.5 25.1%
LPG 674.2 850 26.1%
Natural gas trading 16,671 20,611.7 23.6%
Petrochemicals 3,600.1 4,293.8 19.3%
LPG and liquid hydrocarbons 4,825.3 4,962.4 2.8%
GAILTEL 69.3 42.6 -38.5%
Others 83.2 980.1 1078.0%
Total 30,522.7 37,496.1 22.8%
(%) of sales 3QFY04 3QFY05 9mFY04 9mFY05
Consumption of raw materials 7.3% 4.9% 7.2% 5.9%
Purchases 58.4% 57.8% 58.0% 59.1%
Staff cost 1.3% 1.4% 1.4% 1.3%
Other expenditure 7.2% 6.5% 7.1% 7.1%

Operating leverage aids margin expansion: For 3QFY05, GAIL has witnessed a 370 basis points expansion in its operating margins on account of lower than proportionate increase in costs. It should be remembered that the company had virtually the entire infrastructure in place to absorb the regasified natural gas from the Dahej terminal, the cost of which is a pass-on to the company. As a result, margins improved on the back of lower outflows. Higher inventory gains during the quarter also have helped the company improve on the operating level.

Other income adds to the bottomline: The bottomline growth of over 64% YoY during 3QFY05 is largely a result of higher other income component, which has grown by nearly 332% during the period. Also helping boost the bottomline was performance at the operating level. But for the rise in interest and depreciation costs, given the company's infrastructure and pipeline network expansion plans, the bottomline would have been much higher.

What to expect?
At Rs 220, the stock is trading at a price to earnings multiple of 9.8 times annualized 9mFY05 earnings (price to cash flow multiple of 8.7 times). GAIL has witnessed a strong volumes growth during the current fiscal as Petronet LNG started operations to the extent of 2.5 MMTPA. This has helped GAIL add to the margins as it also realizes marketing revenues, as part of its contract with BPCL and IOC to market their share of gas allocation from Petronet LNG. Also contributing to the margins could be the fact that the company uses rich gas (gas consisting of propane and butane and other value added hydrocarbons) for its petrochemicals and LPG business and the lean gas (after extraction of propane and butane) is re-introduced into the pipelines for use by power and fertilizer companies, resulting in marginal costs for the company.

GAIL has ventured into upstream gas exploration business in a conscious approach to reduce dependence on ONGC. The gas from the Myanmar fields are likely to filter into numbers in 2007 and this would provide a further fillip to the company in terms of volumes.

Petronet LNG is likely to operate at full capacity of 5 MMTPA in FY06 and this would further add to the volumes, given that GAIL has an obligation to market 60% of the natural gas, while it has contracted for the marketing of balance 40% with IOC and BPCL. We believe, going forward, this is likely to result in robust volumes for the company given the huge demand in the country for natural gas, which is not likely to be satisfied despite some gigantic fields beginning production in 2007.

We had recommended a ‘BUY' on the stock at Rs 189 with a price target of Rs 249 in FY05. The stock breached our target price before falling to current levels. At this juncture, we maintain our view on the stock.

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