What Makes This Beaten-Down Gas Stock A Top Brokerage Pick 

That’s largely on the back of GAIL (India) Ltd.’s cheaper valuation, risk management of U.S. liquefied natural gas portfolio, strong core transmission business outlook and a turnaround in its petrochemical segment.

India’s largest gas distributor has only one ‘Sell’ rating on its stock, while nearly 90 percent—the highest in the S&P BSE Oil & Gas index—of the 39 analysts tracking the company have a ‘Buy’ rating. The upside potential for this beaten-down stock is also the highest among its peers.

GAIL’s shares have declined by nearly a third so far this year on the back of concerns around splitting its gas marketing and transmission businesses, weaker crude oil prices and petrochemical product margins and lower-than-expected tariff hikes.

It buys LNG at contracted prices in the international market and sells at prevailing rates in both the domestic and international markets—a business that generates 70-75 percent of its revenue. But while selling prices have tumbled, the fall in buying prices has been lower. GAIL has three active long-term LNG contracts to buy gas—two with the U.S. and one with Russia. The landed cost of U.S. LNG, which contributes more than 69 percent of its import volumes, is at a 31 percent premium to the Singapore spot price.

However, despite lower spot gas prices in 2019 against higher long-term contracted prices, GAIL has been able to generate profit. It has also been able to sign forward contracts to sell its U.S. LNG volumes till 2020. This risk management in the gas trading business has kept analysts bullish on the stock.

Nearly five months ago, the Petroleum & Natural Gas Regulatory Board approved an integrated tariff rate for two of the key pipelines managed by GAIL. While the new rate is 18 percent higher, it’s nearly 58 percent lower than what the gas producer had asked for.

Separately, if the company adopts a lower corporate tax rate, then pipeline tariffs could also be revised downwards to match the pre-determined returns used to calculate tariffs. Soon after the government’s decision to reduce corporate tax rate, the regulator floated a public consultation document to carry out tariff review for natural gas pipelines based on the reduction in corporate tax rates from 30 percent to 22 percent.

The outlook on the gas transmission business, however, remains firm on the back of completion of three fertiliser plants and the government’s focus on reducing air pollution. The completion of three urea plants by Hindustan Urvarak & Rasayan Ltd. in addition to Ramagundam Fertilizers and Chemicals Ltd. is expected to add 9.4 mmscmd (million metric standard cubic meter per day) of volumes for over the next three-four years, Motilal Oswal said in a note.

The National Green Tribunal recently passed an order banning all coal gasifiers in Gujarat’s ceramic manufacturing hub of Morbi, which led to gas consumption almost doubling in the region. Similar orders for other industrial clusters may result in a significant jump in gas volumes.

Weaker crude oil prices, lower petrochemical margins and plant shutdown impacted the LPG and petrochemical segments of GAIL. Petrochemical segment’s operating profit has been negative for the last three consecutive quarters, while LPG segment’s margin has fallen to 25.5 percent from 55.7 percent.

Analysts are also bullish on GAIL as they expect a seasonally strong second half for its LPG segment and stabilisation in its petrochemical plants after shutdowns. That coupled with the 12.5 percent cut in the domestic gas prices for the second half of financial year 2020, would likely lower input costs for LPG business, boosting profits.