Weekly beeps - Reforms Measures and Anticipated RBI Rate Cut puts markets on higher 9/6/12

After the troubled month of May, which saw a major decline in the Indian markets, the first week of June has brought some cheer to the investors who witnessed some strong positive momentum, thus providing the much-needed relief. On June 6 the Sensex recorded the highest single-day gains in the past one year. However, the rally this week mainly on the Hope of a rate cut by the RBI and due to the reform measure taken by the government as regards the petrol price hike. 

Benchmark Indices
Index	1-Jun-12	8-Jun-12	% Change
SENSEX	15965.16	16718.87	4.72
NIFTY	4841.6	5068.35	4.68

The market in the previous week saw a sharp correction after the economy witnessed the weakest GDP growth of 5.3 per cent for the March quarter. The government, as a result, took some hasty steps to bring the economy back on its growth track by outlining an ambitious agenda to put infrastructure projects in a fast forward mode. Prime Minister Manmohan Singh on Wednesday sent out a strong signal stating that the government meant business and that the initiatives were part of efforts to pull the economy out of “turbulent weather” and move towards 9 per cent annual GDP growth.

However, a lot still needs to be done on the policy front to bring the economy back on the high growth track and till then the upward movement in the markets is unlikely to be sustained. In the immediate term all eyes would be on the Reserve Bank of India’s mid-quarter review of the monetary policy for 2012-13, which is scheduled for June 18, 2012.  Prior to this event the April month IIP figures will be announced on June 12 which will give more clarity to the government and to the markets.

Meanwhile, there are some concerns which are still persisting in the economy, one of which is the depreciating rupee which continues to be a major headwind for the economy. However, it has shown signs of appreciation but is still stringently high above the comfort zone. The rupee is currently trading at 55.14 against a dollar. And Brent crude in the last one week dropped significantly to USD 97.86 after which it came down on Thursday from the level of USD 125 in the past couple of months to less than USD 100 per barrel, which is good for Indian economy. But the depreciating rupee has offset some of this benefit.

Currency Rate
Index	1-Jun-12	8-Jun-12
USD	56.355	55.364
EURO	69.39	69.2125
GBP	86.2	85.6398
JYP (per 100)	72.06	69.88

Key Global Indicators
Index	1-Jun-12	8-Jun-12
Gold	28,944	29,341
Silver	55,330	53,849
Crude Oil (Brent)	100.03	97.86
Crude Oil (Nymex)	85.07	82.31

The global markets are currently very sensitive to credit problems, especially from the European region. Fitch has cut Spain’s credit rating to BBB and left it two notches from junk, citing the cost of recapitalizing the country’s banking industry and a lengthening recession. Further uncertainty about Greece exiting the euro zone has added woes to the investors’ sentiments. The clarity on Greece exiting the euro zone may only come post the election results expected on June 17.

Meanwhile, the other Asian markets like Nikkei closed in the positive territory as China surprisingly went for a rate cut by 25 bps to keep up the pace of the economy. The slashing of the rate was the first time in a long period of four years which signifies that China is facing a serious slowdown in its current environment.

Top Gainers/Losers
Gainers	CMP	% Change (WoW)	Losers	CMP	% Change (WoW)
Pantaloon	167.05	20.31	Guj Gas Co	298.5	-10.51
REL	501.9	16.60	Indrapra G	225.85	-9.42
L&T	1309.05	15.39	GSPL	65.7	-6.81
HDIL	72.8	14.38	Adani Ente	227.35	-5.23
IB Real Es	58.2	14.12	NeyveliLig	81.35	-4.57
RelinceCap	339.75	13.86	UltraTechC	1399	-4.00
Sun TV	257.65	13.65	Titan Inds	213	-3.86
Uco Bank	76.85	12.85	EicherMoto	2176	-3.68
JSW Energy	47.1	12.01	MphasiS	354.7	-3.57
TTK Presti	3007.35	11.05	ColgatePal	1144.95	-3.18

The Chinese rate cut triggered speculation about Saturday’s data points. Tension also prevails over the precarious fiscal health of Spain and its fragile banks. Greek elections on June 17 will start playing on investors’ minds from next week. The following couple of weeks also has key events lined up, especially the FOMC meet and G-20 summit.
For India, next week will be important, as the Government will release the latest IIP and inflation reports. The two data points could well have a bearing on the outcome of the RBI’s June 18 policy meeting which will decide the direction thereon.

Research Report - Gas Authority of India Ltd.

 

Market Data Price on reco. date (Rs) 332 (BSE) CMP - BSE / NSE (Rs) 332 / 332 Change since reco.  -0.1% 52-week High/Low (Rs) 477 / 301 NSE Symbol GAIL BSE Code 532155 No. of shares 1268.5 m Free float 42.7% Market cap (Rs m) 421,142 Rs 100 invested is now worth Stock price performance GAIL Index* 1-Yr -25.4% 9.1% 3-Yrs 4.1% 3.4% 5-Yrs 11.1% 3.5% * BSE Sensex Returns over 1 year are compounded annual averages (CAGR) Shareholding (Mar-2012) Category (%) Promoters 57.3 Banks, FIs and MFs 26.0 FIIs 13.3 Others 3.4 Total 100.0

Investment Rationale Source: Company data Near term concerns over penalize stock: It was in April 2011 that we had come up with a report on Gas Authority of India Limited (GAIL) with a 'HOLD' recommendation. Since then, the gas sector in India has witnessed some drastic changes. The gas supplies from Reliance's KG D6- a key source of domestic gas supplies that were projected to double then have actually fallen drastically and are expected to go down further. GAIL being the largest player in domestic gas transmission and trading has been an obvious victim. Apart from the domestic gas shortage, the stock price has been battered down due to downward revision of transmission tariffs (with retrospective effects) on around 75% of the existing transmission network and one off provisions. But GAIL has not succumbed to these adverse factors. The company management has in a very short span of time replaced the shortfall from domestic gas volumes with imported gas. Being an experienced player and market leader, GAIL is well placed to secure the best deals in imported gas .As alternate fuels are becoming pricier; the demand of gas energy in India is bound to go up. We expect the gas supplies to improve substantially post FY13 as expansion of LNG (liquefied natural gas) terminals is completed and gas supplies are increased from marginal domestic fields. GAIL with its expansion plans for pipelines and gas procurement and supply contracts seems to be well placed to make the most of demand supply gap. Also, we expect the company's performance to improve further once it completes expansion of high margin Petrochemical segment by FY14. As far as regulatory issues are concerned, we believe that with downward revisions in transmission tariffs in the recent past, the worst is over. Also, the concerns over a cut down in marketing margins of gas trading segment seem overdone as margins on major chunk of gas traded by GAIL are already approved by the Government. Since our last recommendation, the stock price has fallen by around 30%. As explained above, we believe that the stock price correction is overdone on near term concerns and offers a great buying opportunity to investors. Hence, we suggest a 'Buy'. GAIL least vulnerable to cut in marketing margin risk: As the regulator is coming down hard on players in the gas industry, there is a risk to marketing margins of the profitable players. However, marketing margins charged by GAIL on gas produced in India (more than 80% of the trading portfolio) are already approved by the Government. As far as margins on imported gas are concerned, they are unlikely to come under the purview of PNGRB (Petroleum and Natural Gas Regulatory Board). Further hit on transmission tariffs unlikely: The transmission tariffs for around 75% of GAIL's existing transmission network have been slashed by Petroleum and Natural Gas Regulatory Board (PNGRB) in the recent past. Hence, we believe that the worst is past the company in this regard and chances of a further downward revision are unlikely. Despite the revisions and fall in domestic gas supplies, GAIL has managed to maintain transmission segment revenues at the levels reported in FY11. LNG port capacity expansion to address volume shortage concerns: The fall in the gas volumes is a key overhang on the stock. As domestic gas supplies are falling, GAIL has shifted to imported gas to meet the domestic demand. Currently, the LNG ports in the country operate at more than 100% capacity. However, they are in an expansion phase and are expected to commence new capacities soon. GAIL's Dabhol LNG terminal with a capacity of 5 million tonnes per annum (MMTPA) is also expected to receive cargoes in October 2012. As per the management guidance, it should operate at full capacity in FY15. Further, with expansion of Dahej's LNG and Kochi terminal, we expect the gas supplies to improve and soothe volume concerns. Source: Company data Expansion of Petrochem division capacity to boost performance: In Petrochem division (8% contribution to turnover and 27% contribution to pretax profits in FY12), GAIL is already working on doubling the capacity of existing plant at Pata, up from 450 kilo tonnes per annum (ktpa) to 900 ktpa. Once that happens, we believe the company's performance to get a substantial boost. Besides, the company is also planning to set up a Petchem complex at Assam (280,000 tonnes per annum). We expect the segment to provide strong revenue visibility and lend support to profit margins from FY15 and onwards. Expansion of transmission capacities: GAIL is planning to expand its transmission capacity from 180 mscmd (million standard cubic metres per day) currently to 300 mscmd by investing in transmission pipelines in next two three years. By that time, we expect the gas supplies to improve substantially (as supplies from extended capacities of LNG ports come onstream and domestic gas supplies improve from marginal fields) and regulatory uncertainties to settle down. Considering the perennial demand supply gap in Indian gas sector, we believe that GAIL will maintain its leadership position and first mover advantage in the industry and reap benefits in the long run. Expanding across the value chain: A presence across the value chain lends more stability to a firm's operations, increases synergies and diversifies and minimizes risk. GAIL is an entity that is diversified not just horizontally, operating in different segments, but also vertically - right from Exploration and Production (E&P) to participation in 31 blocks in City Gas Distribution (CGD) through subsidiaries like GAIL Gas and Joint Ventures (JV) like IndraPrastha Gas (IGL) and Mahanagar Gas. Subject to the approval of PNGRB, the company plans to extend presence in more cities through its other JVs. Better appeal than other fuels from a cost point of view: Fuels like Petrol, diesel and coal are substitutes of natural gas. The recent increase in Petrol prices, shortage of coal and impending increase in diesel prices should all work to boost up the appeal of natural gas as a fuel. Recently, the Finance Minister in the Budget has suggested full basic duty exemptions to power plant fuels like natural gas and LNG. Apart from these, a thrust on environmental reforms will push the demand for cleaner fuel like natural gas/LNG. Financially strong to fund expansion plans: GAIL's debt to equity ratio currently stands at 0.23. It has plans for capex worth Rs 73.5 bn in FY13 and plans to fund 60% of it through borrowings. We believe that the company's financials lend enough comfort to raise that amount for borrowings. It's gearing levels post this are expected to increase to over 40% from currently which is well within comfort zone.

Investment Concerns Volume stagnation with extended transmission network: GAIL is on a network expansion spree and intends to expand its transmission network from 9500 km to 14,000 km and transmission capacity from 180 mscmd to 300 mscmd over next two to three years. Any kind of negative development - structural or policy based, that affects availability of domestic gas or imported gas poses the biggest risk to company's prospects in the future. This could lead to the risk of capacity under utilization and poor returns in invested capital Marketing margins could be capped: While in the present the chances of this happening are unlikely, in future it all depends upon Government's views and policies. It may give the Board the power to decide the marketing margins. However, coming up with and implementation of any such development is going to be a long process and we believe that imported gas will be kept out of regulator's purview. Lack of clarity on subsidy sharing: GAIL being a significant player in the upstream segment is expected to compensate for a part of under recoveries that state run oil marketing companies incur on selling LPG, PDS Kerosene and diesel at controlled rates. As of now, there is no fixed mechanism to share it and it is decided on an adhoc basis. This uncertainty regarding subsidy outflow remains a key concern as it can drag the profitability. In FY12, GAIL's net profit growth was limited to just 3% YoY due to 51% YoY growth in the subsidies to Rs 31.8 bn. Without it, the net profit growth would have stood at 17% YoY. Delay in supplies from incremental LNG import terminal capacities: Despite a substantial fall in domestic gas supplies, GAIL has been able to maintain transmission volumes almost at the previous year levels by substituting domestic supplies with imported gas (mainly spot cargoes). In the near future, the volumes from imported gas are expected to lead to growth in transmission volumes. The incremental volumes are expected to come from incremental LNG port capacities. However, since existing ports (Petronet's Dahej terminal) are already operating at more than full capacity, any delay in commissioning of new capacities /ports will lead to stagnation in transmission volumes. Petchem division margins may come under pressure: Post capacity expansion, the Petrochemical division may have to work on costlier imported gas. If the prices of the end products don't increase in a similar proportion, it may adversely impact the margins. Also, higher supplies from Middle East pose a risk. Background Source: Company data GAIL is the country's largest gas transmission and gas trading company. It has more than 75% share in domestic gas transmission and over 50% share in natural gas trading. While Natural Gas trading remains the major revenue driver of the company with 74% contribution in FY12, Natural Gas transmission drives the company's profitability (38% contribution to pretax profits in FY12). In FY12, GAIL handled 117.6 million standard cubic meters per day (mmscmd) of gas transmission. The company has a pipeline network of 9,500 kms in place with a transmission capacity of over 180 mmscmd which it plans to expand to 300 mscmd (pipeline length expansion to 15,000 from 9500 km) in next two three years. GAIL is a significant player in Petrochemicals business with a production capacity of around 450,000 tonnes per annum and enjoys a market share of around 21% in the segment. The company further plans to expand the capacity of Petrochemical division by 100%. It is also involved in manufacturing LPG and liquid hydrocarbons, LPG transmission, City Gas Distribution and has presence in the upstream segment (participation in 31 Exploration and Production/Coal bed methane gas blocks). Industry prospects Last one year has been quite eventful for gas energy sector in India. The domestic gas supplies from a key source - Reliance's KG D6 fields have fallen drastically half and are expected to decline further. As the demand of gas remains strong, the domestic gas at subsidized prices is being replaced by costlier imported gas (regasified liquid natural gas - RLNG). Still, after a strong supply phase in the last two years, the growth in the gas supplies will be slower until the incremental capacities at LNG importing terminals start operating. Also, there have been significant changes on the regulatory front. Petroleum and Natural Gas Regulatory Board (PNGRB) has been quite active during the year with downward revisions in pipeline tariffs and there are fears of a cap on marketing margins on gas trading. In the background of above developments, India still remains an under penetrated market as far as share of gas energy in meeting energy needs is concerned. With cost of alternate fuels rising and environmental norms becoming tougher, we expect the demand of natural gas to remain robust. This means that we will need to either augment domestic supplies or substitute them with the imported gas. Also, once gas supplies come at healthy levels, the clear winner will be the player that has enough supplies and transmission capacity already in place. GAIL being the largest player in gas energy space with further capacity expansion plans and with its proactive approach in tying up contracts for LNG seems well placed to benefit. Key management personnel Mr. B.C. Tripathi - Chairman & MD, is a Mechanical Engineer. He joined GAIL during its inception in 1984 from ONGC. He was one of the initial team members involved in the construction and commissioning of the HVJ pipeline system. He subsequently assumed charge as General Manager (Projects) and later as Executive Director (Projects). He took over as Director (Marketing) in July 2007. He has over 28 years experience in the natural gas Sector. Mr. S. Venkatraman - Director, Business Development is in charge of GAIL's Business Development, Project Development, Petrochemical operations, Exploration & Production and global ventures of the Company. He joined GAIL as Manager in December 1990 and served at various levels across different departments including Business Development, Marketing and Projects. Prior to his assignment as Executive Director (BD), he was in charge of Marketing for various products of GAIL Mr. P.K Jain- Director Finance is a CA and an MBA in Finance from the University of HULL, United Kingdom, Mr. Jain has an experience of over 34 years in Finance and Accounts and worked as Executive Director (Internal Audit) before joining as Director (Finance). Mr. Jain has wide exposure and expertise in the area of financial and treasury management. He also has a rich experience in the area of project evaluation, financial appraisal of projects and headed finance team during execution of major projects of GAIL like pipelines, petrochemicals, E&P, Pricing, Tariff Determination, Risk Management and Internal audit. In GAIL, he has been involved in various specialized areas including mergers and acquisitions with due-diligence exercises of overseas ventures, finalization of LNG Purchase agreement from Ras Gas, Qatar for Petronet LNG Ltd. (Joint Venture of GAIL). Risk Analysis Sector: Domestic Natural gas supplies have fallen drastically and are expected to go down further. The regulator also seems to be coming hard on the gas sector players. From a medium term perspective, the concerns regarding supplies and viability of business stand valid. That said, the future of the sector in the long term looks strong. As demand of gas continues to outpace supply and new supplies expected from imports and marginal domestic gas fields, we believe the sector will see a lot of progress in the times to come. Hence, we assign a 'medium' risk rating to the company on this parameter. Company's standing: GAIL has the largest market share in most of the segments that it is present in. Even as the entire gas sector is facing issues of domestic supply shortage, the company management has been very proactive in securing contracts for imported gas. As far as regulatory risk is concerned, the company has already faced a downward revision in transmission tariffs and the worst seems to be past the company. Hence, we assign a 'Strong' rating. Sales: GAIL generated average revenues to the tune of nearly Rs 279 bn (US$ 5.1 bn) each year over the last five years. Further, in the latest financial year (FY12), the company has earned over Rs 400 bn. We, thus, assign a low-risk rating of 9 to the stock. Operating margin: Operating margin is a measurement of what proportion of a company's revenue is left over after paying for variable costs of production such as raw materials, wages, and sales and marketing costs. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt. The higher the margin, the better it is for the company as it indicates its operating efficiency. GAIL's average operating margins for the past five years stands at around 18%. For FY12, the margins stood at around 14.1% and going forward, we them to come down marginally. As such, we assign a medium risk rating of 6 to the stock on this parameter. Long term EPS growth: GAIL has grown its net profits at a CAGR of 9.2% in the past three years. GAIL is the leading player in gas segment and demand of gas in the country remains high. As per our estimates, average annual profit growth comes at 12.5% over the next three years. As such we assign a medium risk rating of 5 to the stock on this parameter. Return on capital invested (ROIC): ROIC is an important tool to assess a company's potential to be a quality investment by determining how well the management is able to allocate capital to its operations for future growth. A ROIC of above 15% is considered decent for companies that are in an expansionary phase. GAIL's last five years' average ROIC stands at around 24% . For the next three years, we expect it to remain in the range of 14% -15%. This is on account of massive capex that GAIL has planned. Hence, we have assigned a medium-risk rating of 6 to the stock on this parameter. Dividend payout: A stable dividend history inspires confidence in the management's intentions of rewarding shareholders. GAIL's average payout ratio has been a decent 28% over the past 5 fiscals and we expect it to maintain the payout ratio. Thus, we have assigned a low-risk rating of 9. Promoter holding: A larger share of promoter holding indicates the confidence of the people who run it. We believe that a greater than 40% promoter holding indicates safety for retail investors. Promoter shareholding in GAIL at the end of March 2012 stood at 57%. As such, we assign a low risk rating of 9 to the stock on this parameter. FII holding: We believe that FII holding of greater than 14% can lead to high volatility in the stock price. The FII holding in GAIL at the end of March 2012 stood at 13.3%. Based on our parameters, we have assigned a medium risk rating of 6. Liquidity: The average daily trading volumes of GAIL's stock over the past 52 weeks stand at nearly 12, 23,570 shares. This level of liquidity level is a matter of comfort, as this might protect the stock from undue volatility in case of exchange of large holdings among market participants/investors. The rating assigned is 9. Current ratio: This indicates if the company is comfortably placed to pay off its short-term obligations, which gives comfort to its lenders .GAIL's average current ratio during the period FY08 to FY12 has been 1.3 times. As per our estimates, the ratio should decline marginally to 1.0 by the end of FY15. We assign a medium-risk rating of 5. Debt to equity ratio: A highly leveraged business is the first to get hit during times of economic downturn, as companies have to consistently pay interest costs, despite lower profitability. Although GAIL's average debt to equity ratio has been 0.21 over the past five fiscals, it is set to increase over the next three on the back of its aggressive borrowing programme. We have assigned a medium-risk rating of 6 to the stock. Interest coverage ratio: It is used to determine how comfortably a company is placed in terms of payment of interest on outstanding debt. The interest coverage ratio is calculated by dividing company's earnings before interest and taxes (EBIT) by its interest expense for a given period. The lower the ratio, the greater are the risks. GAIL's average interest coverage ratio has been above 50 the past five years . It is expected to be in the range of 18 to 21 over the next three years which is in our comfort zone. We assign a low risk rating of 9 to the stock on this parameter. P/E Ratio: The P/E ratio (price-to-earnings ratio) of a stock is a measure of the price paid for a share relative to the per share income or profit earned by the company. This is one of the important metrics to judge the attractiveness of a stock and thus gets the highest weightage in our risk matrix. GAIL's P/E on trailing twelve month earnings stand at 11.5 times. As such, we have assigned low risk rating of 7 to the stock on this parameter. Considering the above analysis, the total ranking assigned to the company is 86 that, on a weighted basis, stands at 7.1. This makes the stock a low risk investment from a long-term perspective. Risk Matrix Rating accorded Rating Weightage* (A) Rating# (B) Weighted (A*B) Sector risk - Medium NA Company's standing - Strong NA Performance parameters Sales 5.0% 9 0.5 Operating margins 5.0% 6 0.3 Long term EPS growth 10.0% 5 0.5 Return on invested capital 10.0% 6 0.6 Technical parameters Dividend payout 5.0% 9 0.5 Promoter holding 10.0% 9 0.9 FII holding 5.0% 6 0.3 Liquidity 10.0% 9 0.9 Safety parameters Current ratio 5.0% 5 0.3 Debt to equity ratio 10.0% 6 0.6 Interest coverage ratio 5.0% 9 0.5 P/E ratio 20.0% 7 1.4 Final Rating** 86 7.1 # Rating has been assigned on the basis of the company's performance over the past five years and expected performance over the next 3 to 5 years. Rating is on a scale of 1 to 10, with 1 indicating highest risk and 10 indicating lowest risk. * 'Weightage' indicates the relative importance in percentage terms of the parameter. For instance, for an investor, given all the performance metrics, return on equity should be the foremost criteria for buying/not buying stocks. ** The final rating has been arrived at by multiplying the rating/points given on each parameter with the respective weightage. Valuations At the current stock price Rs 332, GAIL's stock is trading at a multiple of 8.1 times our estimated FY15 earnings. In the last one year, the stock has lost around 25%. While the falling gas domestic gas volumes do remain a concern for the sector, the market valuations suggest this has been more than priced in. With regards to regulatory risk, transmission tariffs for more around three fourths of the existing pipeline capacity have already been revised. Since GAIL will be focusing more on the business from LNG sales, we believe that it is unlikely that its marketing margins (on imported gas) will be regulated. As per our estimates, GAIL's standalone earnings will register an average annual growth of 12.5% over FY12-FY15E. As per our valuations using Sum of the Parts (SoTP) method, our target price implies a point to point return of around 43% from the current levels. Our target for the stock stands at Rs 475 from a 3 years perspective. This translates to an average annualized return of around 13.6%. Hence, we recommend a 'BUY' on the stock of the company. Valuations (Standalone nos, Rs m) FY12A FY13E FY14E FY15E Net sales (Rs m) 403,980 473,498 569,617 680,691 Net profit (Rs m) 36,539 39,816 44,770 51,971 No. of shares (m) 1,268 1,268 1,268 1,268 EPS (Rs) 28.8 31.4 35.3 41.0 BVPS (Rs) 170 191 214 240 Price to earnings (x) 11.5 10.6 9.4 8.1 Price to sales (x) 1.0 0.9 0.7 0.6 Price to book value (x) 1.9 1.7 1.6 1.4 Source:Company data,Equitymaster estimates Financials at a glance Standalone (Rs m) FY12A FY13E FY14E FY14E Sales 403,980 473,498 569,617 680,691 Sales growth (%) 24.1% 17.5% 20.3% 19.5% Operating profit (EBITDA) 56,981 63,922 75,189 85,767 Operating profit margin (%) 14.1% 13.5% 13.2% 12.6% Net profit 36,539 39,816 44,770 51,971 Net profit margin (%) 9.1% 8.4% 7.9% 7.6% Balance Sheet Fixed assets 260,678 322,445 383,462 417,980 Current assets 94,680 120,286 136,684 162,407 Investments 35,489 38,100 43,100 48,100 Total assets 390,847 480,831 563,247 628,487 Current liabilities 101,865 121,068 144,495 176,084 Net worth 216,245 242,026 271,014 304,666 Total debt 66,580 111,580 141,580 141,580 Other liabilities 6,158 6,158 6,158 6,158 Total liabilities 390,847 480,831 563,247 628,487 Source:Estimates & Company data

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