Macquarie: Cairn India- Operational excellence vs. Deal confusion

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Cairn India
Operational excellence vs. Deal confusion
Event
 Cairn India (CAIR) reported a PAT of Rs20.1bn in line with estimates (growth
of 27% QoQ) as stable production from the ramped-up Rajasthan block
boosted revenues 15% QoQ and higher crude prices boosted profits. With the
stock having declined 8% in the past 3 weeks due to confusion surrounding
the Vendata group takeover being stuck with regulatory approvals, our target
price range has been reached. Due to crude prices remaining strong and the
Egypt crisis providing an additional push, we upgrade the stock to a Neutral
from an Underperform, with a TP of Rs 292 (vs Rs 294 earlier).

Impact
 Operational excellence, further ramp-up on schedule: Rajasthan Mangala
production was at an approved plateau of 125K bpd. Notably, CAIR currently
has approval to produce 175K, and awaits further approvals. Management
said that Mangala is ready to produce at 150Kbpd (pending GoI approvals.
Train 4 of the surface facilties (75 kbpd) is on schedule for 2HCY11 start-up to
take capacity to 205K bpd; and is synchronised to the Bhagyam production
startup, which is expected to ramp-up to 40kbpd by end-CY11.
 Mangala oil realizations up 8.6% QoQ; discounts to Brent widen to ~15%
Rajasthan gross realizations were at US$74.6/bbl. CAIR’s total opex also
increased to US$2.7/bbl (US$2.4/bbl in Q2), which is still significantly below
the company’s long-term steady-state estimate of US$5/bbl
 CY11 US$1.2bn development capex; Exploration aimed at Rajasthan:
Cairn India expects to spend US$1.2bn on drilling more development wells.
Exploratory drilling is expected in Rajasthan (subject to further approvals by
GoI), Sri Lanka deepwater block (3 wells in H2CY11), KG onshore block, and
NELP VIII commitments.
 Deal or no deal..Interests to be protected: The Vedanta group acquisition
hangs in the balance due to contentious issues regarding royalty, but the
management said that CAIR board recently reiterated its commitment to
protecting the interests of minority shareholders in the course of the deal.
Importantly, CAIR does not have any written demands from GoI for the deal.
Earnings and target price revision
 <1% cut in FY11-13E PAT due to higher Mangala crude discounts on account
of widening Light-Heavy spreads; TP adjusted to Rs292 (from Rs294).
Price catalyst
 12-month price target: Rs292.00 based on a DCF methodology.
 Catalyst: Clarity on acquisition by Vedanta group; Approvals for further drilling
Action and recommendation
 While Cairn India continues to be expensive on EV/1P reserves of US$50/bbl
(Peer mean US$18/bbl) due to its low 1P reserves, our DCF-based valuation
of Rs292/sh incorporates its operational excellence of delivering more than
expected volumes from its high 2P+2C resources, at controlled costs. CAIR
also turned net cash positive (US$194m) during the course of the quarter