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Tariff hikes, transmission volumes to drive FY26E profitability

* GAIL’s 2QFY25 performance was in line, with transmission EBITDA being stable QoQ, petchem turning profitable again in 2Q (on higher volumes), and trading business performance being largely in line with expectations. We see three catalysts ahead for FY26-27: 1) potential ~10% tariff hike for the transmission business in 4QFY25; 2) moderate but sustained growth in transmission/marketing volumes in FY26-27 (with potential for upside if spot prices correct meaningfully); and 3) petchem capacity more than doubling by the end of FY27 from the current 810 KTA.

* Key takeaways from the earnings call:

* GAIL expects 5mmscmd p.a. growth in marketing volumes over the next two years. For the trading segment, EBIT guidance of INR45b has been maintained but is expected to be exceeded. Management expects Petchem segments 2Q EBIT run-rate to continue in 2HFY25. Capex in 2HFY25 shall be higher than 1H, taking FY25 capex to INR90b-INR100b (earlier guidance of INR114.5b),

* GAIL plans to add around 80 new CNG stations and 120k new D-PNG connections in the next two years, and 500ktpa PDH-PP (propane-based plant) at Usar is likely to start commercial production by Oct’25 (75% complete), and a 60ktpa Polypropylene plant at Pata (91% complete) is expected to be commissioned by Dec’24.

* We reiterate our BUY rating on GAIL with an SoTP-based TP, which values:

* the gas transmission business at 9x FY27E EBITDA of INR93b,

* LPG transmission business at 8x FY27E EBITDA of INR5b,

* gas trading business at 6x FY27E EBITDA of INR62b,

* petrochemical business at 7x FY27E EBITDA of INR28b, and

* LPG business at 6x FY27E EBITDA of INR19b.

* Adding the value of listed and unlisted investments of INR272b and adjusting FY27E ND of INR151b, we arrive at our revised TP of INR265.

EBITDA in line; lower DDA and higher other income drive a beat on PAT

* GAIL’s 2QFY25 performance was in line, with transmission EBITDA being stable QoQ, petchem turning profitable again in 2Q (on higher volumes), and trading business performance being largely in line with expectations.

* EBITDA was up 7% YoY at INR37.4b (in line with our est. of INR37.5b).

* PAT rose 11% YoY to INR26.7b (14% above our est. of INR23.4b), led by higher other income and lower DDA vs. our estimates.

* Natural gas transmission volume stood at 130.6mmscmd (vs. our est. of 128.5mmscmd; 131.8mmscmd in 1QFY25). We believe transmission volumes are already at peak (and in line with our est.) and unlikely to materially surprise from hereon in 2HFY25.

*  Petchem sales rose 34%/35% QoQ/YoY to 226tmt (vs. our est. of 212.6tmt), leading to an EBIT of INR1.7b for the petchem segment.

* In 2QFY25, GAIL incurred a capex of INR18.9b (INR35.4b capex incurred in 1HFY25), primarily on pipelines and petrochemicals.

*  In 1HFY25, GAIL’s net sales/EBITDA/PAT grew 4%/36%/35% to INR665.9b/INR82.7b/INR54b. In 2H, we estimate net sales/PAT to increase 9%/1% YoY, while EBITDA to decline 7% YoY.

Segmental EBIT details for 2QFY25

* The gas transmission business posted an EBIT of INR14b (up 9% YoY; our est. of INR13.1b).

* LPG transmission’s EBIT stood at INR855m (in line YoY).

* Marketing business posted an EBIT of INR13.3b (down 26% YoY; our est. of INR13.2b).

* The petchem segment recorded an EBIT of INR1.6b (vs. EBIT loss of INR1.6b in 2QFY24; our est. of INR572m).

* LPG and HC reported an EBIT of INR2.5b (vs. EBIT loss of INR167m in 2QFY24).

Valuation and view

* We reiterate our BUY rating on GAIL with a TP of INR265. During FY24-27, we estimate a 14% CAGR in PAT driven by:

* an increase in natural gas transmission volumes to 149mmscmd in FY27 from 120mmscmd in FY24;

* substantial improvement in petchem segment’s profitability over 2HFY25- FY27 as the new petchem capacity will be operational and spreads are bottoming out;

* healthy trading segment’s profitability with guided EBIT of at least INR45b.

* We expect GAIL’s RoE to improve to ~16% in FY26 from 9.5% in FY23, with a healthy FCF generation of INR73b in FY26 (vs. -INR45.3b in FY23), which we believe can support its valuations.

* Our SoTP-based TP includes:

* the gas transmission business at 9x FY27E EBITDA of INR93b,

* LPG transmission business at 8x FY27E EBITDA of INR5b,

* gas trading business at 6x FY27E EBITDA of INR62b,

* petrochemical business at 7x FY27E EBITDA of INR28b, and

* LPG business at 6x FY27E EBITDA of INR19b.

* Adding the value of listed and unlisted investments of INR272b and adjusting FY27E ND of INR151b, we arrive at our revised TP of INR265.

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