Stock Review: GAS AUTHORITY OF INDIA LTD

While GAIL India's long-term prospects appear intact, concerns over lower gas availability will remain an overhang on the stock in the near term. The gas transmission business forms nearly 70 per cent of GAIL's overall revenues and, hence, slower ramp-up in volumes will hit its financials (return ratios) significantly.

Further, competition could hit its profits. Amit Mishra of Enam Securities believes the Street has ignored the threat of competition from Gujarat State Petronet Ltd, which can put the viability of GAIL's North India pipeline network in question. On the other hand, a quick ramp-up in gas supplies, lower subsidy sharing and upward revision in final rates of the Hazira-Vijaipur-Jagdishpur (HVJ) and Dahej-Vijaipur (DVPL) projects would act as catalysts for the scrip. Most analysts believe under-utilisation of its transmission network will hit gas volumes in the near term, since incremental gas supplies from various sources (KG basin, LNG terminals at Kochi, Dahej) are likely to resume after 2012-13. However, any execution delays in these will be a key risk.

The company has also raised its petrochemical business capacity (nine per cent of sales), which will contribute to earnings by 2013-14. Also, as crude oil prices are at a peak, analysts rule out any material improvements in realisations and expect afive to 10 per cent downside here in the near term. Says Niraj Mansingka, oil & gas analyst at Edelweiss Securities, "For the quarter ended June, GAIL is expected to post revenue growth of 24 per cent, while net profit is seen falling eight per cent on a year-on-year basis."

LOWER UTILISATION, RETURN

GAIL is expanding pipeline network from the current 8,000 km to 14,600 km by 2013-14. This will raise its total capacity of 170 million standard cubic metres per day (mscmd) to 414 mscmd by then. These pipelines will connect Haryana and Punjab with Karnataka, Andhra Pradesh, Tamil Nadu and Kerala. It aims to invest `30,300 crore towards this expansion. While its pipelines in North India will be operational in the current year, those in southern India will start running in 201314. With limited incremental gas at its disposal in the initial two years, the higher costs (depreciation, interest) will impact profitability in the interim.

According to Petroleum and Natural Gas Regulatory Board regulations, at 75 per cent capacity levels, GAIL should deliver 12 per cent return on capital employed. However, lower utilisation of its new pipelines would lead to a fall in its return on equity below 12 per cent levels. Motilal Oswal Securities' analyst, Harshad Borawake, believes with the increase in fixed assets by 70 per cent, earnings will be depressed due to noncommensurate increase in revenue and higher expenses. This will result in low return ratios over the next couple of years.

Analysts believe GAIL's compounded volume growth in gas transmission is likely to fall to nine per cent over the next two years versus 13 per cent seen since 2007-08. While GAIL's volume growth in the past two years was driven by KG-D6 gas supplies, 2010-11 witnessed a 17 per cent drop in KG-D6 gas volumes to 50 mscmd. Analysts expect rampup in KG-D6 fields to start only after 2013-14. GAIL is likely to get gas from the KG blocks of Oil and Natural Gas Corporation and Gujarat State Petroleum Corporation (GSPC) from 2012-13. While Dabhol and Kochi terminals' gas supply are expected to come online by March 2012 and March 2013 onwards, respectively, that from Turkmenistan (TAPI) will start only after 2016-17. Thus, for the next two years, GAIL would see lower incremental gas supplies.

MORE COMPETITION

Intensifying competition in the gas marketing business could threaten GAIL's leadership position in this field. While Reliance Industries and GSPC are its major competitors in Gujarat, it could lose to GSPL, a subsidiary of GSPC, in the North India markets. GSPL, in a joint venture with the oil marketing companies, is expanding aggressively to capture demand in Madhya Pradesh, Rajasthan, Haryana and Punjab markets. Further, GSPL's lower rates, as well as strategically located assets, will provide it a significant competitive edge over GAIL, believe analysts. Additionally, the rising number of LNG terminals will also heat up competition in GAIL's LNG business, thereby impacting its margins in the longer run.