Buy GAIL Ltd for the Target Rs.210 by Motilal Oswal Financial Services Ltd
Valuation rich; potential tariff hike a key catalyst
* GAIL’s 1QFY26 EBITDA/PAT came in 7%/9% below our estimates at INR33.3b/INR18.9b, as petchem and LPG segments delivered weak performance. 1QFY26 revenue included a one-time settlement gain of ~INR1.3b related to past differential tariff adjustments. EBITDA/PAT, adjusted for the settlement gain, came in 11%/15% below our estimates. While natural gas (NG) transmission volumes stood below our estimate at ~121mmscmd, EBIT, adjusted for the settlement gain, stood in line with our estimate. NG marketing volume was in line with our estimate at 105mmscmd. Petchem sales were above our estimate at 177tmt, while the petchem segment reported an EBIT loss of INR2.5b.
* GAIL’s management revised down its NG transmission volume guidance to 128/136mmscmd for FY26/27. Volume weakness in 1Q was driven by reduced refinery shipping volumes, muted power sector demand due to the early onset of monsoon, and unscheduled fertilizer plant shutdowns. However, marketing segment EBIT guidance of INR40b-45b for FY26 is maintained. Owing to weak 1Q NG transmission volume and expected lower power and fertilizer demand in the near term, we also cut our NG transmission volume assumption by 6/7mmscmd to 124/131mmscmd for FY26/27. Further, we build in NG marketing segment EBIT of INR36b for both FY26/27.
* Valuation not inexpensive anymore: GAIL currently trades at 1.4x FY27E P/B, with FY27E RoE of 12%. Further, we estimate a mere 1%/2% EBITDA/APAT CAGR over FY25-27E, as we cut our FY26/27 earnings estimates by 4-8%. However, we are not currently building in any tariff hike related to the INGPL tariff revision. As per our estimates, the final tariff is likely to be in the INR67-71/mmbtu range (currently INR58.6/mmbtu). Every INR5/mmbtu increase in tariff implies a 6-7% increase to our current FY26/27 PAT estimates.
Key highlights from the management commentary
* The Durgapur-Haldia section of JHBDPL has been completed. Now, Bengal Gas and other CGDs will be connected, clocking potential volumes of 0.4mmscmd.
* The current NG transmission volume run rate stands at ~127mmscmd, with the QoQ increase primarily driven by the restart of fertilizer plants and the Pata petchem plant.
* GAIL’s SA CGD business currently operates 212 CNG stations and has 4.4 lakh D-PNG connections, with 1Q volumes at 0.46mmscmd (0.17/0.29 mmscmd APM/R-LNG). It plans to add 85 CNG stations and over 0.15m DPNG connections over the next two years.
* GAIL Gas reported 1Q volumes of 7.03mmscmd and revenue/PAT of INR29.3b/INR1.1b. It currently operates 664 CNG stations and aims to add over 260 stations and 0.3m D-PNG connections over the next two years.
* GAIL has set a capex target of INR120b for FY27, with planned allocations of INR25b for transmission, INR40b for petchem, INR20b for renewables, INR14b for operational capex, and the balance for other segments.
Petchem and LPG segments weigh on overall performance
* In 1QFY26, GAIL’s EBITDA was 7% below our estimate at INR33.3b. EBIT of the NG transmission, NG marketing, and LPG transmission segments beat our estimates, while EBIT of the LPG, LHC, and petrochemical segments came in below our estimates.
* Reported PAT was also 9% below our estimate at INR18.9b, as other income and depreciation stood below our estimates. Moreover, the tax rate was higher than our estimate.
* Operational performance:
* Natural gas transmission volume stood below our estimate at 121mmscmd (our est. 124mmscmd). NG marketing volume stood in line with our estimate at 105mmscmd.
* Petchem sales were above our estimate at 177tmt, while the petchem segment reported an EBIT loss of INR2.5b.
* GAIL’s 1QFY26 capex stood at INR32.8b, spent primarily on pipelines, petrochemicals, and equity contribution to JVs, among others.
* GAIL has received PNGRB’s authorization to expand the capacity of its JamnagarLoni LPG pipeline from 3.25mmtpa to 6.5mmtpa. The estimated capex for the project is INR50b, with completion targeted in three years.
Valuation and view
* We reiterate our BUY rating on GAIL with an SoTP-based TP of INR210. During FY25-27, we estimate a 2% CAGR in PAT as we build in:
* an increase in natural gas transmission volumes to 131mmscmd in FY27 from 127mmscmd in FY25;
* healthy trading segment profitability with guided EBIT of at least INR40b-45b in FY26.
* We expect RoE to improve to ~12.3% in FY27 from 9.5% in FY23, with a healthy FCF generation of INR55.3b in FY27 (vs. -INR45.3b in FY23), which we believe can support its valuations.
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