CAIRN INDIA: Pumped Up for a Good Show with a Lot in Reserve

The stock has lost favour with the market in a falling oil price scenario. Nevertheless, its strong cash flows, debt-free status and high return ratios make it a good defensive bet in a volatile market

    At a time when the overall investment scenario is clouded with uncertainty an investor should stick with companies that have strong cash generation capacity, de-leveraged balance sheet, excellent execution record, high return ratios and good management. Cairn India fits the bill perfectly. The stock has fallen recently in line with international oil prices. However, a long-term investor should view this as an opportunity to invest in a good business at an attractive valuation.Accumulating the stock is recommended on dips. 

BUSINESS Cairn India is India’s largest private sector crude oil producer with its key asset in Rajasthan, where it holds a 70% stake, producing at 175,000 barrels per day. In addition, it holds stakes in two other producing assets — the Ravva offshore field in Andhra Pradesh and CB/OS-2 in Gujarat. The company’s remittances to the government in the form of royalty, cess, profit petroleum and tax jumped in FY12, which restricted its profit growth.
As a precondition to the Vedanta Group’s acquisition deal the company had to accede to the government’s demand to pay proportionate royalty on production in Rajasthan. During FY12 it paid 3,688 crore as royalty and 1,566 crore as profit petroleum, as against none last year. Its cess payments jumped 34.7% to 1,285 crore and are likely to go up even further with the government raising the cess to 4,500 per tonne from 2,500 earlier. 

INVESTMENT RATIONALE Cairn India has entered the MSCI Emerging Market Index from May 31, 2012. This is bound to create more interest among overseas institutional investors.
Although crude oil prices have fallen by over 15% in the last couple of months, the rupee’s depreciation has cushioned the impact to a large extent. Crude oil prices are likely to remain low in the coming months, but should once again start moving up as global economic conditions improve.
Cairn India has displayed strong project execution skills in the Rajasthan block to achieve major milestones in raising the output. It recently upgraded its estimate of recoverable reserves from the block to 1.7 billion barrels, a rise of 20% from 1.4 billion barrels estimated a year ago. This can support a peak production rate of 300,000 barrels per day (bpd) compared to the earlier estimate of 240,000 bpd.
The company has made a couple of high potential discoveries in the Sri Lanka and KG onshore blocks. Development success there can mean higher production potential in future.
The company recently formalised its dividend policy to distribute 20% of its profits as dividends every year. At the current level of consolidated profits, the company can generate around 2.6% of dividend yield. This may not appear attractive right now, but in another 3-4 years for today’s investor the yield will surely become attractive. 

FINANCIALS Cairn’s consolidated revenues have grown at a cumulative annualised growth rate (CAGR) of 102.3%, while net profit grew at 114.6% in the last three years. The company has become debt free with a net cash balance of 7,893.6 crore as on March 31, 2012.
The company’s average daily gross operated production in the March quarter stood at 180,293 barrels of oil equivalent (boe), with working interest at 107,292 boe. 

VALUATIONS Cairn is currently trading at 7.8 times its consolidated earnings for FY12 and a price-to-book-value ratio (P/BV) of 1.3. This is attractive compared to ONGC’s P/E of 9, but in line with Oil India’s P/E of 7.5, both of which are yet to publish their March quarter results. 
Entry to MSCI Emerging Market Index from May 31, 2012, is bound to increase overseas investor interest in Cairn India