Cairn India: Fairly Priced, But Some Concerns Prevail

MUMBAI: Cairn India’s stock has lost some steam after seeing an excellent run-up of 60 per cent from its 52-week low of Rs 250 in August last year to its 52-week high of Rs 400.95 on this February 22. The stock is down around seven per cent from its high to Rs 373 levels currently.
The spectacular run-up in the stock was led by rising crude oil prices benefiting Cairn’s profitability and growing oil production, with expectations of further ramp-ups. While these are positive for the company, analysts believe that most of it is reflecting in the stock price.
However, the increased leverage on Sesa Sterlite after the Vedanta group restructuring proposal has raised some concern on Cairn India, with regard to the higher cash payout (dividends, etc) and its long-term reserve accretion plans. In the light of the run-up in the stock and these issues, many analysts have also turned a bit cautious.
Recent Bloomberg data shows a change in analyst recommendation, with more than 70 per cent of them having ‘Hold to Bearish’ stance on the stock; the one-year consensus price target is Rs 362.
The merger will lead to Sesa Sterlite having a combined stake of 58.9 per cent in Cairn India. Analysts at Kotak Institutional equities observed in their report that while potential impact on Cairn and its cash-flows will have to be watched for, reinvestment of cash in value-accretive E&P opportunities will be treated positively by the market and payment of dividends will be neutral to shareholders. However, any ‘movement’ of cash to group entities other than through dividends will be construed as negative by the market. For now, in the group restructuring, no movement of cash from Cairn has been indicated, though speculations on dividend have been increasing.
Alok Deshpande at Elara Capital points out that Cairn’s annual operating cash flows of over $2.4 billion from FY13 onwards should be sufficient to manage the planned capex to reach 240,000 barrels per day (in production). However, investors may get cautious about Cairn’s ability to efficiently execute the longer-term reserve accretion plan in Rajasthan as it starts potentially high dividend payouts, considering Vedanta’s high leverage levels. He observes that the management has hinted towards a good dividend payout as long as the capex plans are covered. But he adds that Cairn may start 30-40 per cent dividend payout strategy, in our view, implying a yield of five per cent, significantly above the two-three per cent range paid out by global E&P majors.
Cairn, already producing 1,25,000 bopd (barrels of oil equivalent per day) for past few quarters from the Mangala fields, plans to exit FY12 with a production level of 1,75,000 bopd from its Mangala and Bhagyam fields in the Rajasthan block. Mangala fields can easily be ramped up to 1,50,000 bopd, as Arindam Pal at Asian Market Securities observes that for this expansion no field development plans will be required to be submitted. Cairn India in its corporate presentation (February 1, 2012) has observed that the Bhagyam field commenced production; safely proceeding to reach its currently approved plateau rate of 40,000 bopd. Thus, the production ramp-up is progressing well.
While Cairn may be targeting the exit rate for FY12 at 1,75,000 bopd, analysts at Citi forecast the same to be achieved by June 2012. They further forecast a production rate of 185,000 and 230,000 bopd to be achieved by December 2012 and Dec 2013, respectively. However, analysts at HSBC Global Research share a slightly different view. They estimate a production rate of 1,65,000 bopd by FY12-end and 2,50,000 bopd by September 2013. They add that operating cost remains below $3 a barrel, which is positive. Cairn in its presentation has shown operating costs of the fields at $2.1 per barrel. It is in the backdrop of the low operating cost that the company enjoys strong Ebitda margins.
Apart from a rise in production, crude oil prices also continue their upward trajectory and are currently at levels above $120 a barrel. Analysts at Macquarie observe that as the US and EU-led oil embargo on Iran bites, India may undergo severe economic stress. However, Cairn India is the obvious gainer from rising prices. For instance, Deshpande has revised his oil price assumptions for FY13, FY14 and FY15 to $115, $110 and $105, respectively. But, he observes there is little upside from current levels (target price of Rs 390) and has ‘accumulate’ rating from the medium-term perspective. Analysts at HSBC in their February 27 report said the stock factors in production and reserves upside fairly. They have changed their ratings from ‘overweight’ to ‘neutral’.