Hold GAIL

GAIL
Hold
Price: Rs421 Target Price (Mar 11): Rs382

Priced for stable tariff

* Tariff concerns reducing…: We reiterate our view that the new
regulations are unlikely to substantially reduce the tariff charged by GAIL.
The new regulations offer a 12% RoCE tariff based on a project IRR
method with life of asset at 25 years. For existing pipelines, the Capital
Employed is based on net block and life of asset is based on the residual
life (25 years – the number of years completed). While GAIL management
has recently stated that the tariffs can actually increase by about 10%
based on the new regulations, we factor in a reduction of about 10%.

* And projects on track…: Most of the proposed projects of the company
are on track. The first phase of upgraded capacity of HBJ pipeline is likely
to go onstream shortly, while the entire upgradation (in three phases)
would be completed by the end of next calendar year. The capex is integral
not only to the volume growth assumptions in our calculations but also the
tariff as outlined above. Hence any significant delays in capex can impact
the tariff calculations, particularly on HBJ.

* Petrochemical capacity expansion is also on schedule and the first phase of
debottlenecking of the existing capacity from 0.41 MMTPA to 0.5 MMTPA
would be ready by August 2010.

* Subsidy issue continues to haunt: Government of India has stated that
LPG and Kerosene subsidy would be borne by Central Government, while
auto-fuel subsidy would be borne by Upstream companies. Now that LPG
and Kerosene subsidy is to be borne by Government, there is no rationale
on GAIL bearing the subsidy. However, during the first two quarters of the
current year, GAIL continued to bear a part of the subsidy and an increase
in the subsidy continues to threaten and impact GAILs valuations.

* Maintain Hold: As stated above, we believe that HBJ pipeline tariffs are
unlikely to decline significantly. Further, over the next one year, GAIL is
likely to benefit from the increased availability of gas and the completion of
the projects. However, the recent sharp run-up in the price captures both
these upsides. Further, any sharp increase in subsidy due to higher crude
price could significantly impact valuations. Hence, we retain hold and
revise the target price to Rs. 382 from Rs. 371.

Note: More intra-day opportunities will be provided
live during the market hours

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