Profits in line with estimates. Despite the higher-than-expected subsidy burden, GAIL reported profits along the lines of Street estimates, owing to strong gas-transmission EBIT margin. The net profit of Rs9.2bn was up 30% yoy on higher gas-transmission volumes. Profit corresponded with our estimate despite GAIL bearing a ~Rs3.5bn subsidy during 2Q, markedly higher than the ~Rs2.2bn we estimated. Gas transmission EBIT, at Rs697/tcm, though flat yoy, was up 15% over the last three-quarter average. The gas-trading EBIT margin was higher, as expected, as the government allowed GAIL to charge a marketing margin on APM gas.

n       Petrochemicals margin subdued: The petrochemicals margin continues under pressure, down 29% yoy and 22% qoq, at Rs25,382 a ton due to a global supply glut. During 2010, 12.7m tpa of ethylene cracker capacity was added globally, squeezing margins.

n       Adhoc subsidy sharing continues. In 2Q, GAIL's subsidy burden (~Rs3.5bn) was ~9.2% of upstream share, up from 6-7% in the last two quarters, re-iterating the adhoc nature of subsidy sharing.

n       Earnings and Valuation. We maintain our estimate and target price and re-iterate our Buy rating on 14% EPS CAGR over FY10-13, due to the doubling of the natural gas pipeline capacity. Key stock triggers are commissioning of a gas-transmission pipeline and a ramp-up in gas supply.  Further, potential upside to ourtarget price is likely from a higher crude price, freedom from subsidy, E&P exploration portfolio and CGD business.  Risks: lower gas-transmission tariffs/volumes; lower petchem margins/volumes; subsidy overhang.