Cairn India - Strong quarter; takeover overhang:: Macquarie

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Cairn India
Strong quarter; takeover overhang
Event
 Cairn India’s (CAIR) 2Q FY11 PAT rose 463% QoQ, way above market
estimates as Mangala crude production ramped-up by 261% QoQ to its 125
kbpd peak ahead of expected timelines. We are increasing TP to Rs256 from
Rs248. We forecast valuation de-rating following Vedanta’s imminent
acquisition and hence re-affirm our UP recommendation.
Impact
 Operational excellence, further ramp-up on schedule: Rajasthan Mangala
crude production has ramped-up ahead of schedule to approved plateau rate
of 125K bpd (2Q FY11 average production of 116K bpd). Management said
that Mangala itself may produce as much as 150K bpd, with Barmer &
Aishwarya an additional 40K and 10K bpd, respectively. Train 4 (75K bpd) is
on schedule for 2HCY12 start-up to take capacity to 205K bpd. Notably, CAIR
currently has approval to produce 175K, and is awaiting further approvals.
Rajasthan crude realization of US$69.5/bbl was at a 10.6% discount to Brent.
 Cost-saving drives spur EBIDTA 2.7x QoQ, PAT 4.6x QoQ: Cairn halved
Rajasthan operating cost to US$ 2/bbl and pipeline cost to US$0.5/bbl vs
long-term guidance of US$1.5/bbl. Also CAIR shall cease high cost trucking
operations following full commissioning of pipeline. Cairn re-structured and
halved borrowings to Rs22.5bn, which would accrue interest savings in the
future. Operational cash flow tripled QoQ to US$337m (Fig 2).
 Further Rajasthan exploration at risk? According to press reports, the
Managing Committee (including regulator) for RJ-ON-90/1 has ruled that no
further exploration should be carried out as the deadline for exploration has
passed. CAIR management stated that this is not the case and that it shall
submit comprehensive exploration plans next year, following on-going seismic
work, re-evaluation and data processing. In case CAIR is not allowed further
exploration, we believe that 40% or 2.5bn barrels in-place “risked prospects,
leads & concepts” resources may be at risk. This could hurt expectations of
large reserve upgrades and, in turn, high valuations. CAIR trades at US$
52/bbl EV/reserves (1P) vs global average of US$14/bbl.
Earnings and target price revision
 To account for faster ramp-up and lowered costs, we have increased nearterm
(FY11E, FY12E and FY13E) PAT by 47%, 12% and 19%, respectively.
Price catalyst
 12-month price target: Rs256.00 based on a DCF methodology.
 Catalyst: Clarity on further exploratory programme.
Action and recommendation
 De-rating risk from acquisition: Parent Cairn Plc is getting a 14%
higher price than CAIR minority holders, which raises corporate governance
concerns. Vedanta’s lack of upstream experience and potential destabilisation
of existing management (which has done excellent exploration
and drilling work so far, in our view), are key risks.