Cairn India- Deal or no deal? :: Macquarie Research,

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Cairn India
Deal or no deal?
Event
 Cairn is the only pure-play crude stock in India, and has gained from the rising
crude prices. We raise our earnings estimates for Cairn India by 4-7% and
target price by 4% in order to factor-in a 15% increase in WTI crude oil prices.
However, we believe that the run-up in stock price more than captures the
rise, and is not factoring in uncertainties in future cashflow generation (a
function of technical expertise that may be destabilized) and utilization
(dependent on control) that may result from the Vedanta deal going through.
We downgrade the stock to an Underperform, with a TP of Rs304.

Impact
 Short-term boost to oil price estimates: Macquarie’s oil economist Jan
Stuart has raised his CY11E WTI crude price estimates by ~15% (while moreor-
less maintaining the longer term estimates) on the back of the Middle East
and North Asia (MENA) crisis affecting crude production, and increasing risks
to supply from those petroleum-exporting countries. A devastating Japan
earthquake and tsunami has added further bullishness to the non-renewable
energy markets, as nuclear power plans in Japan have been shut.
 Pre-conditions for deal watered down: According to media statements, the
oil ministry has watered down its pre-conditions for allowing the Vedanta
takeover of Cairn India. While earlier it was proposing that Cairn withdraw its
cess-arbitration and share royalty (currently being paid 100% by ONGC,
amongst others); a tough stand by Cairn India / Cairn Plc management and
some fruitful meetings between the Prime Minister and the Vedanta group
Chairman have resulted in the deal being delayed but not doomed, in our
view. It is likely to be reviewed by the Indian Union Cabinet in the near future.
As we go to publication, unconfirmed media reports state that the Indian
market regulator SEBI has made final observations on the deal.
Earnings and target price revision
 FY11E and FY12E PAT estimates increased by 4% and 7% respectively. TP
increased to Rs304 (+4.2%).
Price catalyst
 12-month price target: Rs304.00 based on a DCF methodology.
 Catalyst: Clarity on Vedanta takeover, and any regulatory pre-conditions
Action and recommendation
 Downgrade to Underperform. Cairn India remains relatively expensive on
an EV/1P reserves of US$54/bbl (peer mean US$19/bbl) due to its low 1P
reserves. Our DCF-based valuation of Rs304/share incorporates its
operational excellence of delivering higher than expected volumes from its
high 2P+2C resources, at controlled costs. We downgrade Cairn to an
Underperform from Neutral following a recent sharp run-up in the stock price.