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Gazprom supply woes hit Q2 earnings…

After two quarters of robust operational improvement, GAIL delivered a weak Q2FY23, with 49% YoY and 60% QoQ dip in EBITDA to Rs17.65bn, and 46 YoY and 47% QoQ decline in net earnings to Rs15.4bn. The earnings were well below our estimates of Rs33.5bn EBITDA and Rs23.9bn PAT. Key reasons for the underperformance: i) sharp reduction in petrochemical segment volumes and margins owing to reduction in LNG supply by ~9mmscmd from Gazprom from May’22, and high gas costs; ii) the ~9mmscmd reduction in LNG supplies also caused a sharp contraction in trading margins, as GAIL had to reduce supplies across segments and also fulfil long-term contract obligations with short-term LNG. As a result, trading segment EBIT fell 66% YoY to just Rs3.6bn (sharply below our estimate of Rs22bn) and was the key driver of the earnings miss. Asian LNG price and US Henry Hub benchmark differentials continue to be material, but with nil gas supplies from Gazprom, both trading segment gains as well as gas availability for the petchem segment would be constrained over the rest of FY23E. We reduce our FY23E assumptions for the trading segment and adjust volume estimates and margins for the petrochemical segment as well. This leads to 14% / 8% lower EPS for FY23E / FY24E and ~10% reduction in the target price. Valuations of just 5.3x FY24E EPS and 4.4x EV/EBITDA remain attractive with our revised target price of Rs135 (earlier: Rs150) implying 52% upside. Reiterate BUY.

* Volumes remain muted: Gas transmission volumes of 107.7mmscmd, petrochemical sales of 95kt and LPG sales of 169kt remained fairly subdued, dragging earnings in Q2FY23. For the rest of FY23E too, volume growth will remain challenging, with lower gas availability from Gazprom and very high prices of alternate gas. This will constrain transmission and trading volumes as well as utilisation of the petrochemical plants (since GAIL uses a basket of sources for gas).

* Margins for transmission the only bright spot: Blended tariffs for the transmission segment at Rs1.71/scm were at 10-quarter highs but, for the reasons mentioned above, trading margins were at 1%, down 500bps YoY, a 7 quarter low. However, largely due to very high gas costs, petrochemical EBIT slipped back into negative territory while for LPG too, EBIT margin of 36% was at a 7-quarter low, dipping 2,600bps YoY. Petchem prices and LPG realisations have however improved by 21% and 42% YoY respectively, which helped ease the pressure of high gas costs for the quarter.

* Reiterate BUY: Structurally, resilient gas demand, growing pipeline connectivity (the Eastern Gas Grid alone should add volumes of ~10-12mmscmd over FY23E-FY25E) and additional delta from petrochemicals (JBF acquisition should also add capacity) implies GAIL can manage the stress of higher input costs for petrochemical and LPG segments over FY23E-FY24E. We do factor-in lower margins for the two segments for FY23E vs our earlier estimates, driving the earnings and target price downgrades. Valuations remain attractive, underpinning our positive stance despite the weak quarter. Reiterate BUY

* Key downside risks: 1) Sharply lower gas consumption trends, 2) stronger than estimated gas price impact on petrochemical / LPG segments, 3) reduction in pricing gap between US LNG and Asian spot LNG prices.

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