Cairn India -Skidding on oil prices, Vedanta deal  Macquarie

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Cairn India
Skidding on oil prices, Vedanta deal
Event
 Macquarie’s global head of oil and gas has lowered our energy commodity
price forecasts to approximately forward-strip levels through 2013, resulting in
a cut of 7% in FY12E and 20% in FY13E Brent crude assumptions, to US$
108/bbl and US$ 97/bbl respectively. Cairn India is arguably the only crude
pure-play in Asia. We cut its TP by 7% to Rs 260/sh to incorporate the impact.
However, the stock has fallen 13% in the last fortnight (and 26% in the last 6
months); hence we upgrade it to a Neutral from an Underperform.
Impact
 Weak economic indicators force oil price cut: The relative resilience in
Brent oil prices has eroded over the last three weeks as the OECD economic
outlook grows murkier and the flight to the US$ accelerates. While we still
expect robust oil demand growth in the non-OECD, we no longer have
confidence that scarcity pricing will be necessary to balance the market. Our
increasingly negative outlook on OECD demand (and the US in particular) has
loosened our forward supply/demand balances and we expect spare capacity
to hover near 5% of demand through 2013. We drop our Brent price
assumptions to US$98/bbl in CY12 (-18%) and to US$95/bbl in CY13 (-20%).
For more details please refer to Jason’s note Link
 Cost-recoverable royalty has hits profits: With the takeover by Vedanta
group almost complete after Cairn India’s acceptance of the value-eroding
pre-condition of making royalty cost recoverable as well as the cess payable
at the higher rate, recurring profits of the company have been hit. Further, a
US$380 mn one-time expenditure for reversion of royalty paid by ONGC on
behalf of Cairn India’s share of production until Q1FY12 to the Government is
expected to sharply impact FY12E profits.
 Permissions for ramp-up may partially offset negative impact: The
acceptance of preconditions also implies that Cairn India’s repeated attempts
to get the Management Committee (of which ONGC was a member, and was
stonewalling the process on account of the royalty and cess issues) to allow
further ramp-up of Mangala to 150 kbpd (possible immediately) and further
increases from the Rajasthan block could be expedited.
Earnings and target price revision
 FY12-14E PAT estimates cut by 10-14%. TP cut by 7% to Rs 260.
Price catalyst
 12-month price target: Rs260.00 based on a Sum of Parts methodology.
 Catalyst: Approvals for Mangala ramp-up and Bhagyam production
commencement
Action and recommendation
 Switch to OMCs: We recommend a switch from deep cyclical Cairn India to
the defensive Oil marketing companies (OMCs) HPCL/BPCL that gain from
reduction in subsidy and the impending startup of complex JV refineries.