Shares of Gail (India) Ltd have risen sharply in the past six months, gaining as much as 50%. Investors appear to be delighted with the volume prospects of the state-owned company’s gas transmission business amid robust demand.
There is also some optimism about the possible turnaround in the petrochemical business, despite a loss at the EBIT level in the past four quarters.
But not everyone is convinced. Earlier this week, analysts at Kotak Institutional Equities downgraded Gail’s stock to “sell” from “reduce”.
“As we noted last month, we believe that despite the recent strong gas consumption data, India’s medium-term gas demand is weak and the long-term outlook is even weaker,” Kotak analysts said in a report on 1 January. Despite a weak profit. , Gail’s additional large capital in petrochemicals (petchem) was a key concern, they added.
As such, the recovery in petchem business profitability is likely to be gradual. However, it helps that the Ebit loss from the petchem business narrowed sequentially in the September quarter (Q2FY24) helped by cost optimisations. This factor, together with a huge pace in the commercial business of gas meant that the profits of Gail exceeded market expectations in Q2.
Management is now confident of exceeding FY24 gas business Ebitda guidance of ₹3500 crore, after the business clocked earnings of ₹2700 crore in the half year ending September (H1FY24). This measure is expected to achieve ₹4,000 crore in FY25.
In the gas transmission business, Gail expects volumes to be at 120 million standard cubic meters per day (mmscmd) in FY24 and increase to around 132 mmscmd by FY25. In FY23, transmission volume stood at 107 mmscmd.
The drop in international gas prices in tandem with strong demand and anticipated higher tariffs will likely benefit the company. Further, the anticipated softness in global LNG prices due to the upcoming commissioning of large capacities in the US and Qatar is expected to drive demand over the years. In particular, the growing demand for LNG is helping to boost Gail’s transmission business. In addition, the increasing availability of domestic gas from producers such as Reliance Industries Ltd, Oil & Natural Gas Corp. Ltd, and Oil India Ltd, are also helping.
Against this backdrop, Motilal Oswal Financial Services forecasts that carryover Ebitda would account for 46% of total Ebitda in FY26, up from 40% in FY23. “This should improve earnings stability,” said the December 28 Motilal report.
To expand the pipeline network, Gail has a capex plan of ₹3,600 crore for FY24. Total capex plan for FY24 stands at approx ₹10,500 crores. In the medium term, Motilal Oswal analysts estimate that Gail will report free cash flow of ₹4,560 crore in FY26 (vs. negative ₹4,530 crore in FY23) despite capex increasing 64% over FY24-26E (against the average for FY19-23).
Meanwhile, Gail is actively evaluating the monetization of its city gas distribution (CGD) assets. It aims to unlock substantial value from its investment in Gail Gas. Among other options, Gail can merge geographic areas with Gail Gas and list it. However, a weak demand outlook in the CGD sector raises concerns.
Currently, the sharp appreciation in the stock suggests that investors are mostly taking the positive development into account, possibly limiting future gains. Investors should watch out for improvement in return ratios, utilization rates and recovery in earnings from the petchem business.