Cairn India -Sharp fall due to royalty overhang, crude decline :: Macquarie Research

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Cairn India
Sharp fall due to royalty overhang,
crude decline
Event
 Upgrade to Neutral due to sharp fall, despite import duty cut being a
negative: Cairn India is one of the key companies that should be negatively
affected by the EGoM’s attempt to reduce under-recovery without raising
prices substantially. We estimate that the 5% crude import duty cut will hurt
Cairn India’s earnings by 9% for the full year. We nevertheless are upgrading
our recommendation to Neutral from Underperform given a sharp 13% MoM
fall in the stock price.
Impact
 Decline in crude prices has pulled away bullishness in the stock: Brent
crude prices have fallen to ~US$105/bbl from the US$127/bbl levels two
months ago. A major contributor to the fall was the recent IEA pledge to
release 60mm barrels of oil, or 2 million barrels per day, from its strategic
petroleum reserves (SPR). The US alone will provide 30mm barrels, while
20mm will come from Europe and the remainder from Asia. (The global SPR
total surpasses 1.6B barrels). The agency cited lost Libyan supplies as the
primary driver behind the action – just the third time the SPRs have been
tapped in more than 30 years.
 Royalty overhang a concern, as Vedanta deal continues to be in limbo:
Vedanta has already taken an 18.5% stake in Cairn India, of which 8.4% is
through the open offer at Rs355/share and a 10.1% stake sale by Petronas at
Rs331/share, and hence is significantly committed to acquire Cairn. The
Group of Ministers (GoM) appointed by the government's Cabinet Committee
of Economic Affairs (CCEA) recently recommended that royalty should be
cost recoverable. Effectively, Cairn India would have to bear the hit. According
to press reports it would be difficult for the CCEA to ignore the
recommendation of GoM, which it appointed.
Earnings and target price revision
 We are cutting our earnings forecasts by 4–5% for FY12/13 and target price
by 1.4% to Rs300/share.
Price catalyst
 12-month price target: Rs300.00 based on a DCF methodology.
 Catalyst: Clarity on royalty issue.
Action and recommendation
 Even after having declined sharply, the stock is quoting at >US$45/bbl on an
EV/1P reserve basis, due to low 1P reserve on account of limitations of
permissions/leaseholds. With no clarity on the Vedanta deal having emerged
as yet and the CAG (Comptroller and Auditor General, India’s central auditor)
accusing the petroleum ministry of having favoured Cairn India through not
enforcing relinquishment of land as per the production sharing contract, we
anticipate that the stock could remain stuck in ‘no man’s land’ for a while. We
recommend a switch to downstream companies Hindustan Petroleum (HPCL
IN, Rs415.25, Outperform, TP: Rs507.00) and Bharat Petroleum (BPCL IN,
Rs663.70, Outperform, TP: Rs794.00)