Despite the compromises that Cairn India had to make to clear its deal with Vedanta, the company holds significant potential to be a good long-term investment. Investors may accumulate shares on dips
Last year has been a bad phase for Cairn India. The close relationship between the company’s stock market performance and crude oil prices was broken when its UK-based promoters tried its sale to the Vedanta Group.
The final culmination of this deal left the company with compromises in the form of royalty and cess payments that will forever mar its profitability. Still, the company holds significant potential to be a good long-term investment and can be accumulated on dips.
INVESTMENT RATIONALE Cairn has implemented the development project for Mangala field in the Rajasthan block in a timely manner. It also demonstrated its ability to proceed with its planned investments even without full statutory clearances to maintain the time schedule.
The company is already at 125,000 barrels per day (bpd) production level and has approvals to increase it to 175,000 bpd by developing Bhagyam and Aishwarya fields. This gives the company 32% production upside achievable by the end of this year and a further 8% by the end of next year. No other Indian exploration & production company has such large production ramp up planned for the near future. Cairn’s production may ultimately touch 240,000 bpd, subject to further investments and regulatory approvals. Cairn is working on a pilot project to introduce an early enhanced oil recovery (EOR) technique in Rajasthan. This is expected to add nearly 300 million barrels to its proven and probable (2P) reserves and take it to 1 billion barrels.
Cairn India is also making progress on other exploration assets. One of its KG basin blocks had a hydrocarbon discovery in an exploratory well. Similarly, it recently discovered natural gas in its block near Sri Lanka. In most other blocks it is gathering 2D/3D data. By the time its Rajasthan field reaches its plateau, the company will be ready to move ahead with exploration and development of its other fields.
The lost link between Cairn’s share price and the oil prices is expected to resume now that the deal hangover is over. Cairn typically sells at 10-12% discount to the Brent crude oil price and is a direct beneficiary of rising oil prices. In the near future crude oil prices may be expected to remain weak, however, the outlook should be more bullish for the long term.
The most significant hurdle, and perhaps the last one, that still remains is the payment of royalty to ONGC for the crude oil produced hitherto. This amount is estimated at 1400 crore and would halve a quarter’s profits. However, this is a one-time expenditure for the company.
BUSINESS Cairn India currently produces nearly 15% of India’s crude oil output from its fields in Rajasthan. The company owns 70% stake in the block, while the rest 30% is with ONGC. Cairn India’s parent company the UK-based Cairn Energy Plc sold a majority stake in it to the Vedanta Group at 355 a share. To obtain necessary approvals, Cairn India had to agree to bear the royalty and cess burden related to its share of production.
FINANCIALS Cairn India’s consolidated revenues and profits jumped more than six-fold in FY11 as it ramped up production at Mangala field. It is just four quarters since the Mangala output commenced, hence year-on-year comparisons have little relevance for the company. The company ended FY11 as a cash-surplus company. With around 2,500 crore of cash generation every quarter it is well placed to carry out E&P projects in its other fields.
VALUATIONS Cairn India is currently trading at a price-to-earnings multiple of 6, which is substantially lesser to ONGC’s 10.7 and Oil India’s 11.6.
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