Initiate GAIL coverage with ‘hold; SOTP-based TP of Rs 145

Transmission is poised for strong growth on gas availability along new pipelines and unified tariffs. Natgas inclusion under GST should have small positive volume impact but transmission tariff cuts, petchem oversupply and domestic gas price floor are headwinds. A sizable pipeline. InvIT could give 20% stock upside but looks unlikely. We see limited upside without further crude rally and initiate at Hold, SOTP-based PT of Rs 145 noting <10% ROCE over FY21-24E.

7.5% vol Cagr in transmission over FY21-24E, ROCE to remain sub-10%. We expect cumulative volume growth of 26mmscmd on a low FY21E base driven by fertilizer, refining and CGD along its new pipelines. With tariffs likely to be lowered c.5% (calc) to adjust for lower corporate tax rate, segment ROCE will remain in single digits.

Trading volatility could reduce, RIL’s domgas a risk. Revived SOE fertilizer plants could consume 10mmscmd of US LNG by FY24E reducing trading profit volatility. But fertilizer plants could find RIL-BP’s domestic gas cheaper if future gas auctions are priced at a reasonable slope to crude posing risk to Gail’s US LNG volumes. Profitability headwinds for polymer business. China aims to raise self-sufficiency in polyethylene (PE) by adding 20% of current global capacity over CY21-23E likely weighing on PE price. New LNG investment drying up in CY16-17 and Covid-related construction delays are expected to strengthen LNG price over CY22-25E likely dragging PE profitability. LPG profitability buoyant, floor price on domestic gas headwind. Decade low domestic gas price and rallying crude are supportive of profitability. A regulated floor to domestic gas price is a key risk.

Limited upside from inclusion of natural gas under GST. GAIL’s transmission and LPG production segments could claim ~Rs 3.5bn (calc) of input tax credit stranded today but are likely to pass these through to customers.

Industrial customers could improve economics by 5-13.5% driving some upside to transmission and trading vol.

Sizable pipeline InvIT could rerate stock. The proposed InvIT could re-rate the valuation multiple of transmission business from 6.5x to 9x lifting GAIL’s fair value 20% (Rs 30/sh) provided sizable assets are transferred. But a small offering looks likely given three pipelines contribute 70% of revenues.