GAIL’s fortunes under stress due to energy market upheaval

GAIL’s fortunes under stress due to energy market upheaval

GAIL’s earnings per share to fall from Rs27 in 2014-15 to Rs24 in 2015-16, says a Credit Suisse report

GAIL (India) Ltd is staring at yet another gloomy year as soft energy prices and poor demand for petrochemicals squeeze India’s biggest gas transmission and marketing company.

GAIL has three major businesses: natural gas, liquefied petroleum gas and petrochemicals.

The largest business—natural gas import, processing and marketing—earns over 60% of GAIL’s operating profit. The company, which signed long-term contracts to buy imported gas when prices were high, is now finding customers reluctant to buy, since gas for immediate purchase is far cheaper.

Also, when gas prices fall, GAIL’s marketing margins— which are linked to gas prices— also fall, said Dhaval Joshi, analyst with Emkay Global Financial Services Ltd.

“GAIL’s troubles across segments are large, and seem likely to persist for a while,” said a 13 April report by the Singapore branch of international brokerage Credit Suisse AG.

The brokerage expects GAIL’s earnings per share to fall from Rs.27 in 2014-15 to Rs.24 in the current financial year, even after assuming oil price at $65 per barrel and no subsidy burden.

GAIL, along with other upstream companies such as ONGC Ltd and Oil India Ltd, shoulder a share of the government’s fuel subsidy burden.

An email sent to GAIL on Thursday remained unanswered.

Emkay, which downgraded GAIL from neutral to underperform, said the company’s profit after tax can decline year-on-year in 2015-16.

Joshi of Emkay explained that a year ago, when spot LNG was priced at $14-18 per million metric British thermal units (mmBtu), GAIL bought LNG in long-term contracts for around $12 per mmBtu and sold locally at spot prices, making healthy marketing margins. Now the situation has reversed, as spot is cheaper by around $5 per unit, forcing customers to delay purchases.

Meanwhile, falling crude oil prices have dragged LPG prices along with it, affecting GAIL’s LPG division—its second biggest business. In the third quarter of 2014-15, the division contributed almost a quarter of GAIL’s operating profit.

“Ebitda (operating profit) for the LPG segment is likely to remain low, and down 25% Y-o-Y (year-on-year) in FY16,” said a report by brokerage IIFL Ltd released on 9 February.

The energy market upheavals have not spared GAIL’s third business either: petrochemicals.

The company on its own, as well as through a joint venture, makes petrochemical products such as polyethylene, high-density polyethylene and low-density polyethylene, which are widely used in packaging, wiring, containers and films.

Like its private sector peer Reliance Industries Ltd, GAIL, too, has been raising its petrochemicals capacity, pegging hopes on a recovery, which is yet to materialize.

Meanwhile, the costly imported gas used to make petrochemicals is burning a hole. GAIL has a long-term contract to purchase 4.2 million tonnes per annum (mtpa) of LNG from RasGas Co. Ltd in Qatar.

“Prices for Rasgas LNG are linked to 60-month average oil prices, and remain elevated; this feeds into GAIL’s petchem facilities, hurting segment profitability. These issues now seem likely to persist for a while,” pointed out the Credit Suisse report, adding the troubles will increase as capacity goes up.

GAIL owns and operates a gas-based petrochemicals plant at Pata near Kanpur in Uttar Pradesh and owns 70% equity in Brahmaputra Cracker & Polymer Ltd (BCPL) at Dibrugarh in Assam. It has an overall petrochemical capacity of 4.5 lakh tonnes.

GAIL is in the process of doubling its petrochemical capacity, which poses two additional problems. “One, its gas requirement doubles leading to higher input cost, and second, we are currently in the petrochemical down cycle and there is no immediate inflection point in sight,” explained the vice-president of institutional equities in a domestic brokerage house.

He did not wish to be named due to his company policy.

Doubling petrochemicals capacity means GAIL will have to use 4.8 metric standard cubic metres per day (mmscmd), up from the current 2.4 mmscmd.

This will hurt GAIL’s petrochemical margins at a time when other businesses too are facing demand pressures, the analyst said, adding the company’s share price will trade in a narrow range for two years.

GAIL has seen its market capitalization fall by a quarter from its peak in end October 2014, when its share price scaled a high of Rs.529.15. During the same time, the benchmark BSE Sensex had climbed 2.87%. On Thursday, the share closed at Rs.396.25, while the Sensex closed 0.46% down at 28,666.04 points.

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