Stock Idea - GAIL

Stock Idea [October 01, 2010]  Sharekhan www.sharekhan.com

Summary of Contents STOCK IDEA  GAIL (India) Cluster: Apple Green Recommendation: Buy Price target: Rs585 Current market price: Rs476 Laying the pipeline of growth  Key points Aggressive expansion in its core gas utility business: GAIL (India) is on an aggressive expansion spree to debottleneck its existing pipeline network and set up new pipelines to link the key upcoming LNG terminals (in Kochi and Dhabol). It has earmarked a capex of Rs30,000 crore for the next four to five years that will result in a strong growth in its core gas utilities business in the coming years.  Blended realisation to sustain: GAIL (India)?s blended tariff would have a limited impact even if the HVJ-GREP-DVPL* tariff declines due to the benefits from the company?s investment into the new pipelines. The additional investment in the development of the pipeline infrastructure would augment the regulated asset base (RAB) and thus would arrest any decline in the blended tariff. The encouraging thing is that the Petroleum and Natural Gas Regulatory Board (PNGRB) has proposed a tariff of Rs53.65 per mmbtu (Rs1,985 per tcm) for GREP expansion, which is double the existing tariff for the HVJ-GREP-DVPL pipeline. Subsidy burden remains as overhang: GAIL (India) has to bear a subsidy burden even though it is not an upstream player like Oil and Natural Gas Corporation and Oil India. The subsidy burden would continue to limit the earnings growth of its LPG business. Moreover, there is a regulatory risk in its core gas transmission business. Buy with price target of Rs585: Despite the subsidy burden, the strong growth visibility in its core gas transmission business would drive its earnings growth of 15% CAGR during FY2010-13. We also see value accretion from doubling of the petrochemical capacity by FY2014, and the exploration & production (E&P) and city gas distribution (CGD) businesses going forward. We recommend Buy on GAIL (India) with a sum-of-the-parts (SOTP) price target of Rs585 (where we have valued the gas transmission business at Rs372 per share and the other core businesses at Rs146 per share; the rest of the value comes from the E&P business and the investments on its books). At the current market price, the stock trades at a price/earnings ratio of 12.7x and EV/EBITDA of 8.2x based on our FY2012 estimates.