Fitch affirms GAIL (India) with a Negative Outlook

New Delhi: Fitch Ratings has affirmed GAIL (India) Limited's Long-Term Foreign-Currency Issuer Default Rating at 'BBB-' with a Negative Outlook.

The utility's rating is capped at the same level as the Indian sovereign rating (BBB-/Negative), based on Fitch's Government-Related Entities (GRE) Rating Criteria, and the Negative Outlook reflects the Outlook on the sovereign rating.

We assess GAIL's Standalone Credit Profile (SCP) at 'BBB', supported by its dominant market position in the regulated gas-transmission business, diversification into other business segments and healthy credit metrics, Fitch said.

We expect EBITDA to increase by around 30% in the financial year ending March 2022 (FY22), after dropping by 6% in FY21. This is based on our forecast for a 6% rebound in India's domestic natural gas consumption (FY21: -5.5%). We also expect higher dividend pay-outs and ongoing capex to cause net debt/EBITDA to rise to 1.8x in FY24, from 1.1x at FY21, though remaining commensurate with GAIL's SCP.

'Strong' State Linkages: Fitch assesses GAIL's status, ownership and control by the state as 'Strong' due to its strategic importance in India's gas transmission. The government has 51.45% direct ownership of GAIL and appoints its board. However, the company operates as a commercial entity. We assess the support record as 'Strong'. Support has been infrequent, given GAIL's strong financial position, but the government provided a 40% capital grant towards the total USD2 billion cost of a large gas pipeline project, Urja Ganga, indicating support would be available, if required.

Strong State Incentive to Provide Support: Fitch believes the socio-political implications of a GAIL default are 'Moderate', as it would be unlikely to disrupt the company's gas-transmission service as long as the pipeline infrastructure was maintained. However, a default would affect new pipeline investments. Fitch believes the financial implications of a GAIL default are 'Strong', as it is a key state-owned borrower. A default would affect the availability and cost of financing for the state and other GREs.

US LNG Price Risks: GAIL's gas marketing segment faces price and volume risks under its long-term Henry Hub (HH) linked contracts from the US, as reflected in negative EBIT of INR4.4 billion in FY21 (FY20: positive INR26.4 billion). Asian spot liquefied natural gas (LNG) prices are linked to crude, making it difficult for GAIL to fully mitigate price risk on its HH-linked US LNG volume.

Part of the segment's FY21 losses were attributable to inventory losses booked following the sharp correction in natural gas prices during the year. GAIL is also exposed to unhedged volume in the face of weak demand and low spot gas prices, as evident by the FY21 losses. We expect pressure on gas marketing margins to ease in FY22 as crude oil price estimates increase and demand for gas rebounds post pandemic-related lockdowns. Steady increase in domestic gas consumption will also mitigate volume risk from US LNG over the next three years.

Improving FY22 EBITDA: Fitch expects EBITDA to improve by around 30% in FY22, driven by GAIL's gas transmission and marketing segments. We forecast GAIL's transmission volume to improve by around 6.5%, in line with a recovery in domestic gas consumption, driving transmission EBITDA growth. We also expect higher crude oil prices to support a recovery in the gas marketing segment, following losses in FY21. EBITDA is likely to moderate for the petrochemical segment, with the segment's EBIT margin falling to around 12% (FY21: 15%).

Dominant in Natural Gas Transmission: Fitch expects ongoing pipeline projects to enhance GAIL's dominant market position over the medium term, which benefits the rating. The stable, non-cyclical and regulated transmission business should remain the key operating income contributor, driving cash flow predictability. GAIL holds around a 70% share of the gas-transmission network and makes more than 50% of natural gas sales in India.

Strong Financial Profile: Fitch expects GAIL's financial profile to remain strong, with net leverage below 2.0x over the medium term (FY21: 0.8x), even with higher capex and dividends. An increasing focus on gas-pipeline expansion and the city-gas distribution segment is likely to keep capex high, with cash outflows of INR70 billion-120 billion a year over FY22-FY24 (FY21: INR57 billion). Capex dipped in FY21 on lower spending during the pandemic-related lockdowns. Fitch expects dividend payouts to rise and remain at around 50% of previous-year net income over the next three to four years (FY21: 24%).

Monetising of Assets: GAIL intends to explore the monetisation of its pipelines through infrastructure investment trusts. We treat this as an event risk, as the timing and pipeline details are uncertain. GAIL has advised that its previous plan of transferring its transmission pipeline assets to a fully owned subsidiary and unbundling it from GAIL has been scrapped.

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