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Superior performance expected ahead – reiterate top pick

* GAIL reported earnings came in higher than our estimates, led by continued outperformance in the Petchem business (owing to multi-year high margin during 4QFY21) and Liquid Hydrocarbon (HC) business (on the back of improvement in realizations). The gas trading business turned profitable after reporting losses in three quarters of FY21 (in line with our estimates).

* We expect gas trading and the Liquid HC business to do even better in the current high spot LNG and Brent price environment. While petchem margins have cooled off in May’21 after being in an uptrend since the start of CY21, spot LNG futures price curve trends around USD10-11/mmbtu.

* As highlighted in our report, titled: ‘Improving macros supportive; upgrading multiple’, fear of losses in the trading segment is a thing of the past as various fertilizer plants get commissioned by FY22-end. All these plants are likely to consume ~12mmscmd of gas. We believe GAIL has already started supplying ~3.5mmscmd of gas to various plants.

* GAIL expects gas transmission volumes to grow at 7-8% YoY over the next 3- 4 years, with further upside after the completion of the national gas grid. Increased demand will primarily be from commissioning of fertilizer plants, ongoing refinery and petchem expansions, and development of CGDs (under the IX-X round). We conservatively forecast transmission volumes of 115/125mmscmd in FY22E/FY23E v/s 104mmscmd in FY21 (110mmscmd in 4QFY21). Every 10mmscmd increase in transmission volumes would result in ~7% rise in FY22-23E EBITDA/EPS.

* Transmission volumes in Apr-May’21 were 10-15% lower, though they recovered to ~110mmscmd in Jun’21. Around 80%/50% of US contracts are tied up for FY22/FY23. Valuing the core business at 10x FY23E adjusted EPS of INR16.5 and adding investments, we arrive at our TP of INR210/share. We reiterate GAIL as our top pick in the largecap O&G space.

Beat on numbers in 4QFY21

* EBITDA stood 17% higher than our estimate at INR25.65b (+4% YoY), driven by better performance in the Petchem and Liquid HC businesses. PAT stood at INR19.5b (19% higher than our estimate, -49% YoY).

* EBITDA fell 23% YoY to INR64.5b in FY21 due to losses in the Trading segment during 9M. Adjusted PAT fell 34% YoY to INR49b (tax rate at 23.4% in FY21 v/s 16.7% in FY20 owing to DTL benefits).

* Update on fertilizer plants: GAIL stated that MCFL has started drawing gas. MRPL and OMPL would ramp up going forward. Ramagundam is already running at peak capacity. The Gorakhpur fertilizer plant is likely to run at peak capacity by Aug-Sep’21. The Matix plant likely to commence operation at full load in 2H, with Barauni/Sindri commencing pre-commissioning by CY21-end.

Valuation and view

* Capex guidance for FY22/FY23 stands at INR70b/INR120b (INR70b in FY21). GAIL is currently executing ~71 projects worth INR470b:

* INR370b for eight pipelines (~7,500km) forming the national gas grid (includes INR110b spent on Jagdishpur-Haldia pipeline). Except Durgapur-Haldia, rest of the Jagdishpur-Haldia pipeline will be completed by Dec’21.

* INR100b for expansion of PATA plant (PP capacity: 60ktpa) and PDH plant at Usar (capacity: 500ktpa) by CY23-end.

* Dabhol terminal has already awarded break water development project to L&T (completion expected by FY22-end).

* With ever-increasing gas demand in India, transmission pipelines would play a critical role in connecting both imported and domestically produced gas with consumers. This would thereby encourage the development of new pipeline infrastructure in the country.

* Despite the outperformance of ~20% in CY21 till date, the stock trades at a discount of ~22% to its one-year forward long-term P/E average. We haven't ascribed any valuation so far to GAIL Gas. If volumes pick up in CGD, especially Bengaluru, then it may result in additional value.

* The biggest risk to our call is a sharp decline in oil price before Fertilizer companies commence operations. The stock is trading at 9.4x FY23E EPS of INR17.3 and 6.2x FY23E EV/EBITDA. Reiterate Buy.

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