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Ease The Gas Pedal GAIL is currently trading at 17x P/E (one-year forward), almost double of its 5- year historical average. While this valuation premium factors in expectation of robust gas volume growth outlook and higher existing tariffs, earnings growth of 4% CAGR over FY09-FY12E makes us wary of its sustainability. Petchem/LHC business (50% of FY09 EBITDA) outlook too continues to be grim. We initiate coverage on the stock with a SELL rating and a 12-month target price of Rs370. Investment rationale Valuations appear rich GAIL's share price has appreciated 100% over the March 2009 lows, implying an expansion in the P/E multiples from 8x to 17x currently. Fundamentally, we believe that current valuations are stretched taking into account earnings growth of 4% CAGR over FY09-FY12E. Transmission earnings growth robust; Petchem drags Commencement of KG-D6 gas, concomitant with the Rs300bn network expansion plan encompassing addition of 7,000km of gas pipelines, we reckon would result in 37% CAGR volume growth over FY09-FY12E. Underpinned by volume traction, transmission EBITDA over the period is likely to exhibit 20% CAGR. The petchem/ LPG division (~50% FY09 EBITDA) with a CAGR of 3% over the same period is expected to dampen overall performance, given a weak environment. Subsidy/HVJ tariff risks exist We model for flat HVJ tariffs, based on the assumption of expansion capex of Rs110bn. Our earnings would reduce by 4% for a 10% reduction in HVJ tariffs.Our subsidy model factors in two-thirds the upstream share of auto-fuel under- recovery for FY10E and FY11E, a sharing scenario which favours upstream. Hence there exists a downside risk. Initiate with SELL; SOTP-based TP at Rs370 We value GAIL on a sum-of-the-parts (SOTP) methodology, and arrive at a 12- month target price of Rs370. This implies 8% downside from current levels and constitutes the basis of our SELL recommendation. Price Rs402 Target Price %Downside Rs370 8%¯ Market Capitalisation Rs509,801mn (US$10,913mn) 52 week range H/L (Rs) 432/186 Shares o/s Daily vol (mn) (mn) 1268.48 1.99 Reuters Bloomberg GAIL.BO GAIL IN Perfm(%) 1M 3M 12M YTD Absolute 6.4 11.2 81.2 95.1 Relative 6.2 8.4 5.6 11.5 BSE Sensex Nifty 16,877 5,033 Source: Bloomberg SELL Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please refer to disclaimer section on the last page for further important disclaimer. Source: Bloomberg Price performance Source: Bloomberg Shareholding pattern (%) INITIATING COVERAGE AMBIT CAPITAL GAIL Wednesday 16, December 2009 Analyst Saeed Jaffery Tel.: +91-22-3043 3203 [email protected] Nitin Tiwari Tel.: +91-22-3043 3252 [email protected] Exhibit 1: Key financials Y/E Mar (Rs mn) FY08 FY09 FY10E FY11E FY12E Total income 188,385 246,632 257,962 289,930 294,530 Gross profit 42,642 43,630 48,302 53,855 57,558 Net profit 27,636 28,263 28,639 29,893 32,060 Earning per share, Rs 21.8 22.3 22.6 23.6 25.3 Debt/ Equity 0.3 0.3 0.2 0.3 0.3 EBITDA margin (%) 22.6 17.7 18.7 18.6 19.5 EV/EBIDTA 11.67 11.40 10.30 9.24 8.64 P/E (x) 18.4 18.0 17.7 17.0 15.8 RoE (%) 21.8 19.5 17.3 15.8 15.0 RoCE (%) 21.9 19.9 19.8 18.3 16.7 Source: Company, Ambit Capital research estimates 3XEOLF 3URP 'RPHVWLF V ),,V 'HF -XQ 1RY 6HQVH[ *$,/5+6

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