GAIL (India): Stepping on the gas? - Hold

Over the past fortnight, the stock of gas transmitter GAIL (India) has shot up nearly 30 per cent, thanks to three factors.

One, the draft of the new exploration regime raised hopes of increase in gas production in the country. In particular, the proposal to allow pricing and marketing freedom for gas, akin to crude oil, is a major positive.

This should hopefully encourage investments in exploration and reverse the trend of falling gas production in the country. That in turn should boost GAIL’s sagging transmission volumes and pipeline utilisation.

Next, the proposed public issue of Mumbai-based city gas distributor Mahanagar Gas, in which GAIL holds nearly half the stake, should unlock value for the latter. Similar to peers Indraprastha Gas, Mahanagar Gas has been consistently profitable with healthy return on net worth of above 20 per cent. GAIL plans to sell more than a quarter of its holding in Mahanagar Gas.

More importantly, reports that Qatar’s RasGas may modify the long-term LNG contract, of 7.5 million tonnes per annum, with gas importer Petronet LNG, also helped the GAIL stock.

Reports, not yet confirmed by Petronet, say that RasGas has agreed to change the pricing formula from 12-month average rates to three-month average rates, and also remove the floor and cap on prices based on 60-month average.

This change would align the cost of the imported gas close to market rates, in effect bringing it down from $12.5 to about $7 an mmbtu. Also, RasGas would not levy the ‘take-or-pay’ liability on Petronet for not picking the entire contracted long-term volumes this year.

These measures, if implemented, would also help GAIL. For one, cheaper imports should mean more supplies and higher transmission volumes.

Also, the input cost for GAIL’s petrochemicals segment will reduce. Besides, the overhang of GAIL’s ‘take or pay’ liability with Petronet will abate.

No surprise then that the GAIL stock, on the back-foot for a long time, rallied sharply. Before the recent spurt, the stock had lost nearly 47 per cent over a year — with good reason. The company’s core businesses have been under rough weather.

Shortage of gas has resulted in volumes slipping sharply over the past couple of years in the mainstay gas transmission and trading segments.

The company’s vast pipeline network remains underutilised, even as depreciation and interest cost remain high.

The petrochemicals business, which is being expanded, has also been under pressure due to high costs – gas, depreciation, interest — and low revenue due to falling crude oil price.

The company has been spared the subsidy burden (providing product discounts to public sector refiners) but this did not change the broad dismal contour. Profit fell more than 30 per cent in 2014-15 and more than halved in the first half of 2015-16.

In the light of recent good tidings, shareholders can hold on their stock but avoid fresh exposure. One, the valuation is not cheap. At ₹367, the stock trades at about 23 times its trailing 12-month earnings, much higher than the average 13 times in the past three years.

Also, the increase in gas supply is unlikely to happen in a hurry. Domestic exploration takes a few years to show results while additional gas imports may be limited in the near term due to capacity constraints.

Besides, whether there are any unpleasant surprises in Petronet’s re-negotiation with RasGas remains to be seen — this will be known when the companies confirm the changed terms and the details. But there is hope, so a wait and watch approach would be apt now.

COMMENT NOW