UBS 'double upgrades' Gail India to buy; sees 25% upside in the stock

UBS has ‘double upgraded’ Gail (India) to ‘buy’ from its earlier ‘sell’ recommendation with a price target of Rs 150 (Rs 80 earlier).

The research and brokerage house believes that the markets are yet to fully price in the upside to realised tariffs (from tariff integration), as well as the scope of India's improving gas demand and GAIL's pipeline expansion.

For Gail, UBS expects 8 per cent compounded volume growth (CAGR) over FY23-26.

This, UBS believes, can trigger a series of margin-led consensus earnings upgrades going ahead.

Their FY24-26E standalone earnings before interest, taxes, depreciation and amortization (EBITDA) estimate is 21-29 per cent ahead of consensus.

At the bourses, meanwhile, the stock surged over 3 per cent in intra-day deals to Rs 122.7 on the BSE on Monday.

In comparison, the S&P BSE Sensex traded flat at around 66,245 levels.

In the last one year, the Gail (India) has been an underperformer, and has lost nearly 28 per cent as compared to a 14 per cent rise in the S&P BSE Sensex, data shows.

Higher tariff

The Petroleum and Natural Gas Regulatory Board (PNGRB) had determined the tariff of INGPL (Integrated Natural Gas Pipeline, or a cluster of nine connected pipelines) of GAIL in March 2023 (effective from April 2023) at Rs 58.61/mmbtu as compared with the Rs 43.87/mmbtu earlier.

The regulator also announced the unified zonal tariffs to be charged by respective entities (including GAIL) in March 2023 (effective from April 2023), and then again revised zonal tariffs in June 2023 (effective from July 2023).

“Consensus transmission tariff estimates seem to partially reflect the March-2023 tariff hike for GAIL's key pipelines, but fail to account for the subsequent unified zonal pipeline tariffs and revenue entitlement.

"Further, consensus expectations of operating expenses for the transmission business do not reflect the material decline in gas cost in FY24 YTD,” UBS said.

Earnings boost

At the fundamental level, GAIL’s FY24-26E transmission revenue, UBS believes, could be 11-19 per cent higher than consensus, driven by 6-13 per cent higher realised tariffs.

Further, higher earnings contribution from the more stable transmission business (52 per cent of segment EBITDA in FY24-26 vs 34 per cent in FY22-23), UBS said, indicates the business is becoming more structural rather than cyclical.

“There is scope of further upward revision in tariffs in the coming months (as the regulator had considered lower gas prices in the previous tariff order), which is not built in our base case.

"The cost of gas used as fuel for transmission has materially declined in FY24 YTD, thereby improving margins.

"We forecast a 42 per cent CAGR in transmission EBITDA over FY23-26.

"A return of the utility nature of the business could lead to a re-rating of the stock,” wrote Rwibhu Aon and Amit Rustagi of UBS in a recent note.

GAIL, Aon and Rustagi wrote, is trading at 24 per cent/50 per cent discount to its 10-year average price-to-book value (P/BV) and price-equity (PE), and a deep discount in investment value, making its risk/reward favourable.

“We double upgrade to Buy and raise our price target from Rs 80 to Rs 150,” they said.

Meanwhile, India's gas demand, as per their estimates, is likely to grow from 165 million metric standard cubic meters per day (mmscmd) in FY23 to 200mmscmd by FY26.

This rise, UBS believes, will be led by a steep ramp up in domestic gas supply (primarily from Reliance Industries and ONGC); ramp up in utilisation of new (Dhamra) and upcoming (Chhara, Jafrabad and Jaigarh) LNG terminals; and lower LNG prices improving affordability.

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