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Bright prospects for Gas transmission business

Gas grid: GAIL is making noteworthy progress in developing JHDBPL pipeline; gas flow has begun from FY20 (full capacity of 16mmscmd to be achieved this year). The KochiMangaluru pipeline commissioning and the potential of Kochi-Bengaluru leg (to be ready by FY24) will further boost volumes, supported by PLNG’s Kochi LNG terminal. GAIL will be laying ~9,000km of pipelines over the next year, thereby supporting steady growth in gas demand in line with increasing availability.

Natural gas transmission: GAIL transports ~65% of the country’s gas consumption and commands ~50% of the pipeline network. In Feb’23, PNGRB announced integrated tariff of Rs 58.61/mmbtu (FY22 tariff Rs 44.2) GAIL has objected to the proposed tariff as it seeks Rs 68.55/mmbtu (SUG cost allocated by PNBRG is USD 3.61 while GAIL’s ask is of USD 5.76) In the last decade, transmission volumes reported muted growth. FY24 volumes are likely to average at 120mmscmd and grow over 20mmscmd by FY26.

Natural Gas Trading: GAIL dominates Marketing, transmission, and distribution of natural gas as it accounts for more than 52% of sales. Volumes have grown at 2.7% for over seven years, and improved margins have seen EBITDA grow by 24% (EBITDA guidance: Rs 45bn in FY24 and Rs 40bn in FY25) GAIL has 5.8mtpa of US HH-linked LNG, of which 2.9mtpa is contracted, hence the impact of volatility would be limited.

Petchem: PATA complex was impacted in FY23 given restricted Gazprom LNG exports, pulling utilisation levels down to ~40% (now back to ~100%). They are currently working on options for sourcing gas at lower prices and firming up term contracts with exporters. Utilisation would be managed at 100% if spot prices stabilize below USD 16/mmbtu. FY26 could pressurise margins due to excessive capacities coming up for key polymers like PP/PE. GAIL has many projects due for commercialize by FY26: PDHPP & IPA at Usar, PP project at PATA, and Mangalore Petrochemical Ltd (JBF Petrochemical acquisition).

LPG and LHC: Gail operates petrochemical complex at PATA to produce polymers and other liquid products, as also Gas processing units (GPU) at Pata, Gandhar, Vaghodia and two at Vijaipur. LPG is sold entirely to OMCs while LHC is sold to industrial customers. Transmission pipeline of 2,038km is in operation with capacity to transmit 3,830tn tons of LPG.

Outlook: The near-term outlook for gas transmission, trading and petchem has discernibly improved following the fall in spot LNG prices. Lower prices could drive higher gas transmission and trading volumes, thereby lowering operating costs.

We believe GAIL’s EBITDA would achieve a 27.6% CAGR over FY23-26e, led by a 36% CAGR in gas transmission EBITDA. The gas transmission business has bright prospects (currently contributing ~56% to EBITDA in FY26e, expected to increase further) while the commodity business is a little volatile. Given the recent rally in the stock price and per our valuation, we initiate coverage on the stock with an ADD rating, at a TP of Rs166, valuing it on a sum-of-parts basis (core business at Rs138, 7.7x EV/EBITDA and investments at Rs28).

Risks: Changes in government regulation policies, smaller natural gas transmission tariff hike, steep movements in LNG, crude and PE prices, slower execution of pipeline expansion plans, slowdown of demand and high capex spends denying good returns.

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