The unexpected and sudden waiver of non-compete fee by Cairn Energy seems to confirm the fears of retail shareholders that Cairn India’s valuations have more risks than what various brokerages would have them believe. The scrip, which had peaked ahead of Sesa Goa’s open offer during April–May 2011, is now trading nearly 15% lower. With crude oil prices on a downward journey, the scrip could lose further value in the coming days. This is surprising when Cairn India had only recently upgraded the production potential of Rajasthan field to 300,000 barrels per day (bpd) from an earlier estimate of 240,000 bpd. Similarly, its estimate of recoverable reserves was raised to 1.65 billion barrels from 0.7 barrels, which was formally approved. The currently approved production level is 175,000 bpd, of which the company has achieved 125,000 bpd.
The voluntary waiver of noncompete fee — or a 12.3% reduction in Cairn’s earlier price — is being termed as the company’s willingness to share the royalty burden with ONGC. Although no official announcement has been made yet, if true, this will have a negative impact on Cairn’s value. According to Goldman Sachs, the royalty burden would reduce more than 15%, or . 62 per share, from its current target of . 405 for Cairn India.
“In case Cairn India has to bear its pro-rata share of royalty, we expect its FY12 and FY13 royalty burden to increase to . 2,430 crore and . 2,940 crore. It will also have to provide for . 1,350 crore towards its share of past royalty. Our base case NAV would decline to . 250 per share from . 305,” says Sandeep Randery of BRICS Securities, assuming oil price at $75/barrel. This will benefit ONGC, which has a stake of 30% in the fields, but pays 100% royalty now. BRICS estimates additional net profit of close to . 1,600 crore for ONGC in FY12, if the royalty is shared by Cairn.
Even after a reduced share price, ONGC appears unlikely to announce a counter offer simply because Cairn Energy and the Vedanta Group, between themselves, control more than 80% of Cairn India’s shares. In such a scenario, a counter offer is bound to fail. Cairn India is now producing from the Mangala field while the Bhagyam and Aishwarya fields are under development. Production of 40,000 barrels per day from Bhagyam is expected to start in the second half of 2011, while the Aishwarya is scheduled to commence operations from mid-2012 onwards.
In the March 2011 quarter, Cairn India reported a 7.5% fall in its average daily gross production to 161,194 barrels as against 174,282 barrels for the Dec 2010 quarter. Resolving the royalty issue is the key concern in Cairn India’s valuations and the risk appears to be rising for the stock now.
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