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GAIL has reported a second successive quarter of robust operational growth in Q1FY23, with EBITDA of Rs43.6bn (up 81% YoY, 18% QoQ, 11% above estimates) and PAT of Rs29.1bn grew 91% YoY and 9% QoQ. Beat on operational front vs ISec estimates was driven by i) stronger trading segment EBIT and ii) marginal beat on transmission volumes, offset by weaker petchem volumes/margins and weak LPG volumes. Very high differentials between Asian LNG prices and US Henry Hub benchmarks continue to drive trading gains for GAIL, albeit with the suspension of ~2mt (~7mmscmd) of gas supplies from Gazprom due to the ongoing geopolitical issues, both trading segment gains as well as gas availability for the petchem segment would be constrained over the rest of FY23E. Our base case estimates were already conservative for trading segment and hence, despite factoring in lower volumes for transmission/trading, we see a small jump in FY23E EPS, while FY24E EPS sees a minor downgrade (adjusted for the recent buyback of 57mn shares). Valuations of just 5x FY24E EPS and 4.0x EV/EBITDA are attractive with our revised target price of Rs225 (earlier: Rs233), implying 60% upside. Reiterate BUY

Volumes remain muted:: Gas transmission volumes of 109.5mmscmd, petchem sales of 109kt and LPG sales of 165kt remain fairly subdued, dragging earnings in Q1FY23. For the rest of FY23E also, volume growth will remain challenging, with lower gas availability from Gazprom and very high prices of alternate gas to constrain transmission, trading volumes as well as utilisation of the petchem plants (since they use a basket of LNG sources for their gas)

Margins for gas transmission and trading improve; petchem, LPG see YoY decline : Both, blended tariffs for the transmission segment at Rs1.68/scm and trading margins of Rs2.5/scm were at 10-quarter highs. However, largely due to very high gas costs, petchem EBIT margin collapsed to a multi-quarter low of 2.4% (1,300bps lower QoQ) while for LPG also, EBIT margin of 44% was at an 8-quarter low, dipping 1,600bps QoQ. Petchem prices and LPG realisations have, however, improved 63% and 35% YoY, respectively, which augur well for margins going forward.

Reiterate BUY: The combination of stronger demand, resilient margins and the additional delta from the new gas pooling scheme (providing access to additional CGD volumes for GAIL’s gas trading segment) means GAIL should be able to largely offset the sharply higher input costs for petchem and LPG segments over FY23EFY24E. We do factor in lower margins for the two segments for FY23E vs our earlier estimates, but this is offset by stronger trading gains (Q1 EBITDA is 50% of our FY23 estimate). Our conviction in GAIL remains intact as mentioned in the foregoing, with valuations at attractive levels. BUY.

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

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