Gail is a low-risk investment option with immediate growth triggers

Lots In The Pipeline

Gail is a low-risk investment option with immediate growth triggers. Its current valuations are attractive for long-term investors

R AM KR I SH NA K ASH ELK AR ET INTELLIGENCE GROU P

    EVEN AMIDST the current market uncertainty and financial turmoil, Gas Authority of India (Gail) stands out as a low-risk investment option with immediate growth triggers. We had recommended this stock in our edition dated March 17, '08. Although the scrip has not lost much in the recent meltdown — declining around 10% since our recommendation, against a 32.6% fall in the Bombay Stock Exchange (BSE) Sensex — its current valuations are attractive for longterm investors. Gail enjoys a monopoly status and an inherent pricing power in cross-country natural gas transmission, as it owns India's largest gas pipeline network. The fact that it is a government-owned, diversified and cash-rich company improves its risk profile. Reliance Industries' (RIL) natural gas, which is expected to start flowing from the fourth quarter of FY09, will benefit Gail to a great extent. Natural gas is a cheaper and better alternative to liquid fuels and there is a huge unmet demand in India. As a result, the company will enjoy the twin benefits of sustainable growth, while keeping risks low, even in times of a global financial turmoil and economic slowdown.
BUSINESS: Gail's business model is well-diversified as it operates in the entire natural gas value chain from processing, transporting and marketing, to producing liquid hydrocarbons and downstream petrochemicals. It is going in for the last step in backward integration of producing natural gas and has invested in 29 exploration blocks and three coal bed methane (CBM) blocks.
    As part of its diversification in natural gas-related businesses, it has invested in liquefied natural gas (LNG), gas-based power plants and gas retailing through city gas distribution (CGD) projects. Its wholly owned subsidiary, Gail Gas, is setting up a compressed natural gas (CNG) corridor on the country's national highways.
    The company is already connected with all the natural gas supply points — Dahej and Hazira in Gujarat, Uran in Maharashtra and now Kakinada in Andhra Pradesh. This makes it a natural transport partner for any large producer or consumer of natural gas. Gail is now laying pipelines on the west coast, which will connect future LNG terminals at Dabhol and Kochi to the national gas grid. In a bid to diversify geographically, the company has gone to countries like China and Mongolia to implement CGD projects.
    Gail produces liquefied petroleum gas (LPG) — one of the heavily subsidised petroleum products in India — and has to suffer a portion of the under-recovery. However, over the past couple of quarters, Gail's subsidy burden has remained flat, despite the spurt in global oil prices, which is directly helping its liquid hydrocarbons business. We expect that even in future, Gail's subsidy burden will remain at present levels, which will allow the company to post decent profit growth.
GROWTH DRIVERS: At present, the company transports over 82 million metric standard cubic metres per day (mmscmd) of natural gas, produces 1.3 million tonnes (mt) of liquid hydrocarbons, including LPG, and nearly 4 lakh tonnes of polyethylene. The company has recently expanded its polyethylene capacity by 25% to 5 lakh tonnes, which will be gradually scaled up to 8 lakh tonnes.
    Gail has embarked on an ambitious plan to invest over Rs 28,800 crore by '12 to expand capacities in areas such as pipelines, exploration & production (E&P), petrochemicals, city gas projects, LNG etc. This entails doubling the natural gas transmission capacity, covering over 200 cities under CGD, 60% expansion of petrochemicals capacity and expanding LNG terminals.
FINANCIALS: Since FY05, Gail's net profit has witnessed a compound annual growth rate (CAGR) of 11.2%, while its sales grew 10.7%. In the quarter ended June '08, the company posted 31% profit growth to Rs 897 crore, on the back of a 35% jump in sales to Rs 5,731 crore.
    The company's LPG and liquid hydrocarbons business, which was making losses in FY07, has witnessed substantially superior profit margins in FY08; in the first quarter of this year, its profit margin touched nearly 40%. Similarly, the natural gas transmission business is showing a steady increase in profit margins. The company recently issued bonus shares in the ratio of 1:2. If the company maintains a 100% dividend policy, as in the past three consecutive years, its dividend yield will be a decent 4% at the current market price (CMP).
VALUATIONS: At the CMP of Rs 243.65, the scrip is trading at a P/E multiple of 11. We expect the company to close FY09 with an earning per share (EPS) of Rs 26.1 and FY10 with an EPS of Rs 32.3. The CMP is 9.3 times the expected FY09 EPS and 7.5 times the expected FY10 earnings. At the same time, nearly 30% of Gail's market capitalisation is represented by the value of its investments and cash. Hence, its core business is available at even cheaper valuations. Existing investors are advised to stay invested in the stock.
ramkrishna.kashelkar@timesgroup.com