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GAIL: Promising prospects - Views on News from Equitymaster
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GAIL: Promising prospects
May 3, 2006

Performance summary
GAIL (Gas authority of India limited) declared its results for FY06 and 4QFY06 results. For the fiscal year, the topline grew impressively by 20% while operating margins were under pressure. However, lower depreciation and interest cost safeguarded the bottomline. For 4QFY06, topline registered a growth of 17% while higher expenditure led to a contraction in operating margins.

Financial snapshot…
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Net sales* 35,880 42,078 17.3% 135,914 163,513 20.3%
Expenditure 26,510 35,034 32.2% 99,884 128,534 28.7%
Operating profit (EBDITA) 9,370 7,044 -24.8% 36,030 34,979 -2.9%
EBDITA margin (%) 26.1% 16.7%   26.5% 21.4%  
Other income 751 844 12.3% 3,491 4,555 30.5%
Interest 316 292 -7.5% 1,341 1,173 -12.5%
Depreciation 2,372 1,391 -41.4% 9,465 5,595 -40.9%
Profit before tax 7,433 6,205 -16.5% 28,714 32,766 14.1%
Tax 2,198 2,112 -3.9% 9,175 9,666 5.3%
Profit after tax/(loss) 5,235 4,093 -21.8% 19,539 23,101 18.2%
Net profit margin (%) 14.6% 9.7%   14.4% 14.1%  
No. of shares (m) 845.7 845.7   845.7 845.7  
Diluted earnings per share (Rs)       23.1 27.3  
Price to earnings ratio (x)         10.4  
*Sales given above is Net sales+ internal consumption.

What is 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 FY06?
Supply side improving: Natural gas transmission, the core business (accounted for 15% of total segmental revenues excluding internal consumption), registered a growth of 4.6% in revenues during FY06. Natural gas transmission volumes increased by 10% in FY06 to 78.9 MMSCMD (million metric standard cubic meters per day). Natural gas trading segment witnessed a growth rate of 25%. This was on the back of increased gas supply from not only Petronet LNG but also from select private players in the western coast. For 4QFY06, the company registered a growth of 17% in the revenues. The growth prospects of GAIL are closely linked to the magnitude of gas supply (both domestic and imports). We are optimistic about the supply from a long-term perspective and therefore, expect revenues to grow at a strong rate. However, in case the transmission charges are lowered by the government, the growth will be muted.

Segmental Snapshot…
Rs. m 4QFY05 4QFY06 Change FY05 FY06 Change
Transmission - Natural gas 5,237 5,635 7.6% 21,927 23,020 5.0%
PBIT 1,678 4,011   11,935 17,260  
PBIT margin 32.0% 71.2%   54.4% 75.0%  
Transmission - LPG 779 944 21.2% 3,018 3,082 2.1%
PBIT 206 497   895 1,583  
PBIT margin 26.5% 52.6%   29.7% 51.4%  
Natural gas trading 20,490 25,495 24.4% 80,291 100,430 25.1%
PBIT 1,036 (615)   2,108 592  
PBIT margin 5.1% -2.4%   2.6% 0.6%  
Petrochemicals 6,498 6,729 3.5% 18,530 19,415 4.8%
PBIT 2,902 2,645   8,042 7,139  
PBIT margin 44.7% 39.3%   43.4% 36.8%  
LPG and liquid hydrocarbons 4,665 4,682 0.4% 18,375 22,017 19.8%
PBIT 1,612 249   6,090 6,046  
PBIT margin 34.5% 5.3%   33.1% 27.5%  
GAILTEL 53 45 -16.3% 188 183 -2.3%
PBIT 156 (4)   (11) (18)  
PBIT margin 292.9% -9.4%   -5.7% -9.7%  
Overall PBIT margins 21.2% 16.0%   21.6% 21.4%  

The petrochemical effect: Margins were under pressure owing to the fact that the government’s notification with respect to the marketing margin on gas trading (with respect to gas trading beyond APM). As is evident from the table above (segmental snapshot), as compared to a profit in 4QFY05, the gas trading division has posted a loss at the PBIT level in 4QFY06. The petrochemical division also posted lower margins owing to higher gas prices and lower prices on certain products. We have a cautious view on petrochemical margins going forward (gas prices are likely to increase in the long-term).

Expenditure breakup…
(%) of sales 4QFY05 4QFY06 FY05 FY06
Consumption of raw materials 9.5% 10.7% 6.8% 8.9%
Purchases 54.1% 60.4% 57.8% 60.6%
Staff cost 2.0% 1.3% 1.5% 1.4%
Other expenditure 8.3% 10.9% 7.4% 7.8%
Total expenditure as % of sales 73.9% 83.3% 73.5% 78.7%

Bottomline: The pressure at the operating level was negated by higher other income accompanied by lower depreciation and interest charges. There was a considerable fall in depreciation charges over the fiscal as it fell by 40% YoY, while the other income increased by 30% during the fiscal.

What to expect?
At Rs 284, the stock trades at price to earnings multiple of 10.4 times FY06 earnings. On the positive side, the company’s investment in city gas distribution (Indraprastha Gas) is a big positive in the long-term. With most of the major metros and industrial cities imposing stricter environmental guidelines, we expect CNG and PNG demand to grow at a faster pace. Also, we believe that natural gas supply prospects are promising over the long-term (from the east coast as well). On the flip side, the government’s policy with respect to subsidy share and the pricing of gas still remain ambiguous. To that extent, one has to exercise caution. But for a long-term investor (with a three year horizon), GAIL is a compelling play, though with a higher risk profile.

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