Cairn India : The only beneficiary of raising Oil Prices !!

Scrip Code: 532792 / CAIRN

CMP:  Rs. 354.35; Buy at current levels
Target: Rs. 370.00
Market Cap: Rs. 67,352.59 Cr.
52 Week High/Low: Rs. 368.05 / Rs. 253.40

Total Shares: 190,07,36,406 shares; Promoters : 118,32,43,791 shares – 62.25 %; Total Public holding : 71,74,92,615 shares – 37.75 %

Book Value: Rs. 167.80; Face Value: Rs. 10.00;
Total Debt: Rs. 3,503.00 Cr; Enterprise Value: Rs. 68,732.59 Cr

Cairn India is an Exploration and Production company, a leading player in the Indian oil and gas industry. Cairn India has its interests in 15 blocks. The firm has made more than 30 oil and gas discoveries in India during the last 13 years, was listed in January 2007 through an IPO after it spun off from its parent Cairn Energy Plc (current stake: 65%). Cairn has working interest in 14 E&P blocks. Ravva and Cambay blocks produce 51.4k boepd (Cairn WI 14k bpd).

Vedanta along with its subsidiary SESAGOA has made an offer of $8.5 - $8.6 billion to acquire controlling stake (51-60%) in Cairn India at Rs405/share with Rs50/share as non-compete fee. The deal will be 20 % from SESAGOA at $3 bln & 31 % from Vedanta. The open offer will be at Rs.355/share. However, the roadblock in the deal due to government and ONGC stand would keep stock price under pressure. Cairn has commissioned three trains at MPT and pipeline section from MPT to Salaya, through which it is delivering crude to refiners.

Latest developments on Cairn-Vedanta deal

The Oil Ministry has imposed 11 pre-conditions on Cairn India and its prospective buyer Vedanta Resources, for approving the deal. ONGC and Vedanta have shown willingness to accept most of the conditions except the change in royalty obligations and surrender of their rights to take legal resource on disputes with the government or its technical advisor DGH.

Currently, Cairn India does not pay any royalty on the crude and has even contested the payment of Rs 2,500 per ton cess on its 70% share in Rajasthan block.

Some of the key pre-conditions are as follows:

Royalty costs recoverable. It means royalty costs should be recovered from the sale of crude oil from the field before profit is shared between the companies and the government. ONGC's royalty obligation is in excess to US$3 Bn (Rs.14500 Cr) for the approved crude oil production for the life-time of the field.

Withdraw arbitration proceedings for Cess: ONGC also wants Cairn to withdraw arbitration proceedings challenging its liability to pay cess for oil produced from the Rajasthan block. The Company is currently paying under protest its share of cess at Rs.2500/Ton.

Guarantees to be provided: Vedanta will have to give financial and performance guarantee same as given by Cairn Energy.

Retain Technical capabilities: Vedanta has to retain the Cairn India's existing technical capability.

Adhere to the approved field development plans: Vedanta has to adhere to the approved field development plans and work programmes of the oil and gas fields as per contracts.

If Cairn India accepts the first two conditions (though looks very unlikely) then the valuations will be very expensive for Vedanta and will not make commercial sense for it to acquire stake in it. ONGC's contention is that its returns from its investment in the field should at least be higher than the cost of capital which is about 13-14%. As per Sebi regulation, an open offer requires 55-60 days to complete. The shareholders approval taken by Cairn and Vedanta is valid up to 15th April'11.

Valuation Details - 

I have tried to value CAIRN India on DCF method of valuation with 12.04% WACC. With the rise in the international crude oil price, the realization for the Company is also expected to improve. However, the stock price has under-performed in spite of improving fundamentals mainly due to uncertainty over the Cairn-Vedanta deal and also on the royalty and cess payment. It is expected that in the next twelve days i.e by 15th April 201, final outcome of the deal should be declared. Based on the current valuations the stock is available very cheap and is recommended to BUY with a target of Rs.378/share.

Based on the Rajasthan exploratory portfolio upsides and advancing production from the MBA block the Fair Value for the stock comes at Rs.378/share. In the DCF model, it is assumed a long-term static average crude oil price of US$86/bbls; Cairn crude oil realization @ 10% discount; Cess at Rs.2575/MT; plateau production at 240kbopd.

Rajasthan production details

In Q3FY11, the average gross production from Rajasthan block was 124.9 Kbopd as compared to 15.43 kbopd in Q3 FY10 and 116 Kbopd in Q2FY11 registering a growth of 709% YoY and 7.6% QoQ basis.

Cash (Net debt) as on 31st Dec'10 was Rs. 870 Cr. The Company replaced its rupee facility of Rs.4,000 Cr with a lower financing of Rs. 2,250 Cr. My estimates is of FY11E EPS of Rs.33.9 and FY12E EPS of Rs.49.9.  Stock is cheaply valued at 4.89x EV/EBIDTA and 6.3x P/E based on FY12 earnings estimates . The Brent crude oil price is trading around USD$107/bbls which is the benchmark for Cairn's crude oil. With the rise in the international crude oil price, the realization for the Company is also expected to improve. However, the stock price had under-performed in spite of improving fundamentals mainly due to the uncertainty over the Cairn-Vedanta deal (royalty and cess payment). It is expected that in the next 3 months, final outcome of the deal should be declared so based on the current valuations the stock is available very cheap and recommended to BUY Cairn India with a price target of Rs.378/Share.
NOW only concern on price movement is  that Petronas, a Malaysian oil major holds 14.91 % of Cairn a 28,34,31,438 shares, the BUZZ is that it may sell its stake in open market in order to save Capital Gain Tax, at current price of Rs.354.35 , Petronas's stake in Cairn is worth Rs.10,043.39 Cr. For which Petronas has shelled out just above Rs.5,000 Cr to buy 28.34 Cr Shares. If sale happens it will cause the prices to fall but the question will be that Why would Petronas Sell? lets hope ....till then some key financials -

KEY FINANCIALS	2010	2011E	2012E
SALES (Rs. crs)	1,623	11,590.6	15,695.1
NET PROFIT (Rs. crs)	1,036	6,433.3	9,457.6
EPS (Rs.)	5.5	33.9	49.9
PE (x)	57.5	9.3	6.3
PRICE/BOOK (x)	1.76	1.49	1.23
EV/EBITDA (x)	58.68	7.05	4.89
RoNW (%)	3.1	17.3	20.9
RoCE (%)	2.2	17.8	24.4

I maintain my BUY status on CAIRN INDIA with the price target of Rs. 370 in short term. As I always say do respect the market and keep a strict stop loss of 8 % on your every purchase.