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Tariff order adds to positive outlook

The regulator PNGRB has finally issued its much-awaited tariff order for GAIL’s integrated pipeline network (link here), which transports ~91% of the company’s current volumes (112.4mmscmd as per PPAC). The PNGRB- determined tariff of Rs58.6/mmbtu is lower than the Rs68.6/mmbtu GAIL applied for, yet is ~35% higher than the current normalised tariffs. This implies a material accretion of ~Rs20bn to segment revenues in FY24E. While this is a tangible positive, there are other drivers of growth as well, as highlighted by the management in the analyst meet (22nd Mar’23). The other drivers are: i) likely growth of 10-12mmscmd in transmission and trading volumes, ii) improvement in LPG margins, iii) likely bottoming-out of petrochemical capacity utilisation, and iv) improvement in gas availability over FY24E-FY26E driven by moderation in LNG prices and higher domestic gas production. Nevertheless, the new tariff order, while being higher vs current tariffs, has assumed lower gas prices than GAIL submissions (which we believe more closely reflect the current pricing outlook). Hence, upside risk exists to these tariffs as and when GAIL applies to have these parameters adjusted post implementation of the Kirit Parikh Committee recommendations.

* Multiple tailwinds in prospect: The tariff revision adds to what we believe is an already strong operating environment for GAIL over FY24E-FY25E. Higher volumes on the back of: i) moderating prices, ii) continued expansion of the gas grid, iii) higher gas availability, and iv) likely improvement in margins and utilisation of LPG/petrochemical segments – are all likely to result in meaningful EPS improvement over FY23E-FY25E.

* Gas supply should improve over FY23E-FY27E: While the near-term prospects for GAIL’s supply mix remain constrained, the softer spot LNG prices can provide some succour, at least over H1FY24E. For the medium term, ~20mmscmd of additional domestic supply and additional LNG supplies by FY25E can ease the supply tightness (various estimates suggest 200-400mtpa of LNG export additions over CY22-CY27E). However, trading margins and petrochemical utilisation are unlikely to reach anywhere near the highs seen in FY22 since the factors that drove the outperformance are unlikely to be repeated anytime soon.

* Marginal changes in estimates, reiterate BUY: We revise FY23E / FY24E / FY25E EPS by -1% / 0% / 2% respectively, to factor-in: i) marginally higher transmission volumes, and ii) sharply higher transmission tariffs. These are offset by lower margin estimates for trading/LPG segments owing to lower LPG prices assumed for FY24E / FY25E and also lower petrochemical utilisation. Despite the recent strength, valuations at 6.6x FY25E EPS and just 5.4x EV/EBITDA remain overly pessimistic and ignore GAIL’s solid business model and revival of long-term growth prospects. Reiterate BUY with a revised target price of Rs132 (earlier: Rs122).

*Key upside risks: i) Higher volumes, ii) resumption of Gazprom supplies, iii) sharper moderation in gas prices.

* Key downside risks: i) Reversal of price trends, ii) slower execution of pipeline expansions, iii) lower petrochemical and LPG prices.

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