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Blockbuster 2Q, even better 2HFY22 ahead

* GAIL reported a 52% beat on our EBITDA estimate, driven by a multi quarter high profitability in the Gas Trading business. Operating performance of other business segments, especially petchem, improved on a YoY and QoQ basis (despite the weakening of petchem margins globally QoQ).

* Management guided that the Gas Trading segment may do even better in 3QFY22 as spot LNG prices increase further (+USD10/mmbtu in 3QFY22 till date). Also, lesser cargoes are now being sold outside India (eight cargoes in 2Q v/s 14 in 1QFY22) on the back of improved demand from the precommissioning and ramp-up of fertilizer plants in India. It remains confident on bringing all cargoes to India over the next one year as Sindri, Barauni, and Gorakhpur fertilizer plants get commissioned.

* The petchem plant is currently operating at more than 100% utilization. GAIL will achieve 100% utilization in FY22, despite a low utilization in 1Q. With the recent improvement in petchem margin, we expect better performance from this segment as well in 3QFY22.

* Gas transmission volumes rose to 114mmscmd on the back of an increase in volumes from CNG and Industrial PNG segment. The management expects the same to touch 120mmscmd in FY23.

* LPG and Liquid HC realization would see a huge jump in 3QFY22 as LPG prices lag Brent prices (+USD10/bbl in 3QFY22 till date) by a month.

* In light of commodity prices turning favorable again for the company and the reality of de-risking US Henry Hub contracts coming to light, we reiterate GAIL as our top pick in the large-cap space.

Beat led by huge gains in the Trading business

* In 2QFY22, EBITDA came in higher than our estimate at INR34.8b (up 160% YoY and 44% QoQ) on the back of huge gains in the Trading business. PAT stood at INR28.6b (53% higher than our estimate, up 131% YoY and 87% QoQ), translating into an EPS of INR6.3 (est. INR4.2).

* In 1HFY22, EBITDA stood at INR58.9b (up from INR19.6b in 1HFY21), with adjusted PAT at INR43.9b (v/s INR14.9b in 1HFY21).

Valuation and view – reiterate GAIL as our top pick

* The management expects 7-8% YoY growth in gas transmission volumes over the next 3-4 years, with further upside on completion of the national gas grid. Increased demand will accrue from the commissioning of Fertilizer plants, ongoing refinery and petchem expansions and development of CGDs.

* Capex guidance for FY22 stands at INR74b (of which INR32b was incurred in 1HFY22). The same for FY23 stands at INR120b. GAIL is currently executing various projects worth INR400b. It is still evaluating prospects of the recently announced hydrogen plant at Vijaypur in Madhya Pradesh.

* The Dabhol terminal has already awarded the break water development project to L&T (completion expected by 3QFY23-end). Petchem expansion at Pata and Usar plants is running on schedule.

* The stock trades at a discount of ~25% to its one-year forward long-term P/E average. We haven’t ascribed any valuation so far to GAIL Gas (current volumes at 5.5mmscmd). If the pickup in volume commences in CGDs, especially Bengaluru, then it may result in additional value.

* Valuing the core business at 10x Dec’23E adjusted EPS of INR15.6 and adding investments, we arrive at a TP of INR200/share. The biggest risk to our call is a sharp decline in oil price before Fertilizer companies commence operations, which may usher uncertainty in the Trading segment.

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