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Cairn India: Higher earnings for higher crude prices, but stock will be range-bound
pending clarity on open-offer deal
Higher earnings for higher crude prices, but stock will be range-bound pending
clarity on open-offer deal. We have revised our earnings estimates for Cairn India to
reflect (1) higher crude price assumption and (2) new exchange rate assumptions.
However, we believe the stock price will be range-bound until more clarity emerges on
the Cairn-Vedanta deal and royalty issue. We do not see the stock price moving in
tandem with crude prices (as has been the case historically) given the overhang of the
proposed deal. Our rating on the stock remains suspended.
Cairn stock is no longer a play on crude oil prices
We note that Cairn stock has historically shown very high correlation to crude oil prices particularly
since it is the only available play on crude oil prices in India currently. However, we note that the
stock has not rallied along with crude prices recently given that the upside is capped by (1) the
proposed open offer of Vedanta Resources (see Exhibit 1, which shows likely returns for a Cairn
shareholder) and (2) pending royalty issue. We expect the stock to be range-bound until more
clarity emerges on the proposed deal. It also seems that the market is finally taking cognizance of
the fact that Cairn’s DCF valuation does not change much with crude oil prices (see Exhibit 2).
Earnings revision for higher crude price
We have revised our FY2011-13E EPS to `26 (+13.4%), `44 (+7.6%) and `47 (-1.4%) to reflect
(1) higher crude oil price assumption, (2) change in exchange rate assumptions and (3) other minor
changes. We have revised our crude price (Dated Brent) assumption for FY2011-13E to US$82/bbl,
US$85/bbl and US$85/bbl versus US$79/bbl, US$81/bbl and US$85/bbl previously. We now model
the exchange rates for FY2011E, FY2012E and FY2013E at `45.6/US$, `45.5/US$ and `44/US$,
respectively, versus `45.5/US$, `44.5/US$ and `44.5/US$ earlier. We compute our DCF-based fair
value (see Exhibit 3) of Cairn India at `305/share (`300 previously). Our long-term crude price
assumption of US$85/bbl and 2% increase in perpetuity post FY2014E are unchanged.
Crude prices will likely soften in the near term
We believe that the recent spurt in crude prices was led by (1) a colder-than-expected winter in the
northern hemisphere, (2) phase-out of certain coal-based power plants in China due to
environmental reasons and (3) increase in speculative positions (see Exhibit 4). We expect crude
prices to soften from the current high levels as these temporary supporting factors fade out. We
see rather subdued fundamentals for crude in CY2011E led by (1) current high OPEC spare
capacity of over 6 mn b/d (see Exhibit 5), (2) decade-high OECD inventory levels (see Exhibit 6) and(3) 1.1 mn b/d increase in non-OPEC supply and NGLs production which will nearly offset 1.3 mn
b/d increase in oil demand in CY2011E
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