Buy Cairn India - Unique play on crude : LKP

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Cairn India Ltd (Cairn) is uniquely positioned in the Indian equity universe due to its strong positive correlation with global crude prices. Cairn is the operator of the world class RJ-ON-90/1 oil block which contains gross 2P reserves of 694 mn bbl, with additional EOR potential of 308 mn bbl. RJ-ON-90/1 stock in place stands at 4 bn bbl, with further exploratory prospects of 2.5 bn bbl. The company has ramped up production from its Mangala field to 125,000 bpd and has guided towards CY11 exit production rate of 175,000 bpd. We estimate peak production level of 210,000 bpd to sustain from FY14 till FY21. High crude prices, exciting E&P prospects and highly competent management combine to position Cairn as an attractive investment opportunity.

Investment Argument

A combination of robust demand, due to positive economic outlook, and reducing spare supply, due to political unrest in the Middle East, has resulted in crude prices sustaining at ~ $ 120/bbl since Mar 2011. Cairn can take advantage of high crude prices as it does not bear any subsidy burden. However, the stock has not reacted positively to crude prices during the last few months due to uncertainty over its acquisition by Vedanta Plc. We expect the Govt. to clear the acquisition without any pre-conditions and also give its approval for the higher peak production level of 210,000 bpd. Hence, the stock price is expected to rise to levels commensurate with current crude levels. In addition, there has been positive news flow from its exploration blocks in Sri Lanka and KG onshore.

Going forward, we expect sales CAGR of 119.6% during FY10-13E owing to production ramp up in its Rajasthan fields. We estimate OPM of ~ 84% during FY11-13 on the back of low cost operations in all its producing blocks. We estimate free cash flow generation to rise from Rs.17.4 bn in FY11 to Rs.89.5 bn in FY13 and cash levels to rise to ~ Rs.158 bn in FY13.

Valuation

We carry out valuation of 2P reserves and arrive at our price target of Rs.392 per share and initiate coverage with a BUY rating. We value MBA (including EOR) using the NPV method and use EV/boe for other Rajasthan reserves, risked prospective resources and Ravva & Cambay. The main trigger for the stock is Govt. approval of its acquisition by Vedanta.

Risks and Concerns

Recurrence of recession in the global or the domestic economy would depress crude oil prices and would have an adverse effect on the company.

Govt. insistence on making Cairn bear the royalty burden on its production from the Rajasthan field would reduce the valuation of the stock.

 

 

 

LKP Research