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Cairn India
Action
Cairn India has underperformed the Sensex by ~15% since the mid-August
announcement of a proposed change in its ownership (and resulting uncertainties
on government approvals). We believe the stock could remain range-bound until
clarity emerges on the deal. But after that, irrespective of the outcome, we think it
could do some catching up as its Rajasthan story remains promising. BUY.
Catalysts
Early clarity on the government’s decision on the Cairn Energy-Vedanta deal,
continued strength in oil prices, and fast ramp-up in Cairn’s MBA production.
Anchor themes
We believe oil prices could strengthen further in 2011, driven by QE-2 and
improving fundamentals. We like Cairn India as a pure oil play and continue to see
significant upside from the Rajasthan block, with nearly 4bn boe of discovered
resources and 2.5bn boe of prospective exploration resources.
Story to continue after a break
Cairn has been an under-performer recently
Cairn India has been an under-performer since the mid-August
announcement of a proposed change in ownership (through the sale
of a 51% stake in Cairn India by Cairn Energy to Vedanta). Over this
period, Cairn India stock is down ~8%, whereas the Sensex is up
~8.4% and spot oil prices have also rallied by nearly 22%. Prior to this,
Cairn India’s stock was positively correlated to oil prices. We would
attribute most of its recent under-performance to uncertainties around
the deal.
Deal or no deal – no impact on Cairn India’s operations
We think the issues around the Cairn PLC-Vedanta deal (government
approvals, pre-emption rights of ONGC, royalties, etc) are procedural
and could get sorted out over the next two to three months. Also, we
do not see ownership issues affecting Cairn India’s operations.
Rajasthan story remains intact
Cairn India’s production ramp-up at Rajasthan has been much
sharper than expected; Mangala reached its peak in 3Q10 ahead of
our expectation of end 2010. Operating costs and crude discounts
remain well within management guidance. Cairn management
remains confident that Mangala can reach 150kbpd (subject to
government approvals) and that the Rajasthan block could produce
240kbpd (vs its current approved peak of 175kbpd).
Twin advantages — defensive and potential upside
We continue to like Cairn as a Rajasthan resource upside story. In
near term, however, uncertainties on ownership issues and open offer
price mean the stock could remain range-bound. Nonetheless, we see
it as a good defensive play and, given its recent under-performance
and the firming of oil prices, we think Cairn could catch up once clarity
on the matter of ownership emerges.
Valuation methodology and risks
We value Cairn India on a sum of the parts basis. We calculate the NAV of its key fields
Mangala, Bhagyam and Aishwariya (under development) and Rageshwari & Saraswati
(FDP approved) using a discounted cash flow (DCF) methodology. Our NAV of MBA and
R&S field is INR276/share. The Ravva and Cambay blocks are valued at INR7/share
and INR2/share, respectively. We value Cairn's 10% share in the 2P reserves in KGDWN-
98/2 block at a conservative US$6/boe. We value recoverable resources
(140mmboe now) in other 20 fields at US$6/boe and prospective resources of 1.76bn
boe (net of recoverable resources) at US$1/boe. We also assign a value of US$6/boe to
exploration upsides (prospective recoverable resources of 250mmboe – Cairn’s share of
175mmboe). Our SOTP value of Cairn is INR369/share, and we round this up to reach
our price target of Rs370. Risks include delays in ramp-up of production, lower oil prices,
higher-than-expected discounts and higher-than-assumed cess.
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