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GAIL: Margin blues… - Views on News from Equitymaster

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GAIL: Margin blues…
Jul 18, 2006

Introduction to results
GAIL (Gas authority of India limited) recently declared its 1QFY07 results. For the quarter, the topline grew impressively by 31% YoY while operating margins were under pressure. However, lower depreciation and interest cost along with increase in other income has enabled a decent YoY bottomline growth of 23%.

Financial snapshot…
(Rs m) 1QFY06 1QFY07 Change
Net sales** 36,242 47,303 30.5%
Expenditure 26,763 37,887 41.6%
Operating profit (EBDITA) 9,480 9,416 -0.7%
EBITDA margin (%) 26.2% 19.9%  
Other income 499 801 60.4%
Interest 297 288 -3.0%
Depreciation 2,391 1,408 -41.1%
Profit before tax 7,292 8,521 16.9%
Tax 2,457 2,600 5.8%
Profit after tax/(loss) 4,835 5,921 22.5%
Net profit margin (%) 13.3% 12.5%  
No. of shares (m) 845.7 845.7  
Diluted earnings per share (Rs) 5.7 7.0  
Price to earnings ratio (x)*   8.1  
* Based on earnings of trailing twelve months.
**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 1QFY07?
Growth across segments: Gail has witnessed growth in its revenues across all the segments. Petrochemical segment (contributing 11% to gross revenues in 1QFY07) witnessed a staggering growth of 50% in revenues, (29% growth in volumes and 17% growth in realisation). Natural gas trading, which is the prime business of the company (with 62% of the gross revenues in 1QFY07) grew by 35% YoY. Natural gas transmission (accounting for 12% of the gross revenues in the quarter) registered a revenues growth of 4% on the back of flat volumes growth and 4% growth in realisations. LPG transmission business witnessed a decrease in realisation, however due to increased volumes, (7% growth YoY) the segmental revenue grew 6% YoY. LPG and liquid hydrocarbon segment (accounting for 13% of the gross revenue in the quarter) registered a growth of 26% in its revenues, as volumes grew by 8% and realisation grew by 17% YoY.

Accelerated input cost: Company sources rich gas and separates C3 and C4 component to turn it into lean gas. C3 and C4 components are used by the petrochemical and the LPG segment of the company. Rising crude oil prices (gas prices move in line with crude oil prices) have been playing havoc with the profitability of Indian oil and gas companies and GAIL has been no different. Although, product prices have risen for the company as evident from the growth in realisations, they have not been enough to completely offset the rise in raw material prices and and as a consequence operating margins have shrunk for the company.

Expenditure break up…
(Rs m) 1QFY06 1QFY07 Change
Purchases 21439.2 30,551.7 42.5%
% of sales 59% 65%  
Consumption of raw material 2,403.30 3,740.1 55.6%
% of sales 7% 8%  
Staff cost 534.3 551.3 3.2%
% of sales 1% 1%  
Other expenditure 2385.7 3,044.0 27.6%
% of sales 7% 6%  

Other income effect: Higher other income (up 60%) accompanied by lower depreciation (down 41%) and interest charges (down 3%) have not allowed the fall in operating profits to trickle down completely at the net level. Consequently, net profits were up 23% YoY during the quarter.

What to expect?
At Rs 233, the stock trades at price to earnings multiple of 8.1 times trailing twelve months earnings. Scenario on both demand as well as supply side looks promising for the company. However, investors have been wary of assigning an appropriate valuation to the company. Much depends on how the regulation scenario in India pans out. Currently, company has to share in subsidy burden. High gas prices also negatively impact its petrochemical business. We are in the process of updating our report on the company and shall soon come out with our view on the stock.

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