• 05 July 2013
• CMP: Rs 294
• Large Cap – Mkt Cap 56,100 crores
• Advice:  Buy

Executive Summary

• Formula for success: rise early, work hard, strike oil – (a quote by J. Paul Getty)
• Cairn India is a large cap and the top Indian private sector Oil E&P firm.
• It has excellent Oil exploration and producing assets. At current Revenue of 17,524 cr, Profits are 11,606 cr and the Cash Flow is 11,000 cr. The business is lucrative in terms of high cash flow, and low operating costs and investments, and debt free status.
• For last 4 years, Operating and Profit margins are excellent at 69%, and 65% on average.
• The demand outlook for oil in India is good, with 70% from imports, and annual growth at 6-8%. Cairn Profits get boosted with a weak rupee and increase in international oil prices.
• The Valuations at a P/E of 4.6 times are very attractive making it a Value play.
• Risks to this investment are: ability to sustain and grow oil production from current fields, make new discoveries from exploration assets, and ability to utilize or share the firm’s cash reserves

Business Snapshot:

• Cairn India is the top Indian private sector Oil Exploration and Production firm.
• The consolidated Revenue is 17,524 cr with Profits 11,606 cr (FY13) and cash balance of 16,713 cr.
• Promoters are the UK listed Vedanta Resources/ Anil Agarwal group, that holds 58%. Vedanta Resources took over Cairn India Ltd (Cairn) from Cairn Energy UK in end 2011.
• It’s a pioneering firm that has opened up the Indian Oil & Gas sector to private sector discoveries. From its first Oil discovery in Jan 2004, Cairn has come a long way to deliver on it’s potential and emerge as the second largest producer of Oil & Gas in India. Cairn’s oil production data are in Fig 1:

Fig 1 – Oil Production at Cairn, Source: Cairn corporate reports

(kboepd – Kilo Barrels Of Oil Equivalent Per Day)

• Current shareholdings are Promoters/Vedanta 58.8%, Cairn Energy UK 10.3%, MF/ DII/ FII 25.7%, Individuals 2.7% and Others 2.5%.
• Cairn has about 1450 employees. It has the exploration assets portfolio in India (7), Sri Lanka (1) and South Africa (1). Commercial production is from Rajasthan, Cambay and Ravva fields in India.
• In addition it owns the Mangala Processing Terminal, the Mangala development pipeline – a 590 km heated insulated pipeline for crude evacuation, and oil infrastructure at Ravva and Cambay.
• The current 205 kboepd oil production includes 175 kboepd from Rajasthan. There is significant upside potential here, with the internal target as 215 kboepd by Mar2014. (Of 95% oil and 5% gas).
• In the longer term there is (the asset evaluations show that the total resource base now provides) a basin potential to produce 300 kboepd, subject to further investments and regulatory approvals.

Fig 2 – Cairn Profit and Cost Metrics, JainMatrix Investments

• Cairn is among the lowest cost producers of Oil, and has among the highest net profit per barrel oil.

Business Model:

• Cairn is paid for oil delivered to refineries. The Cairn business model is sensitive to the international oil prices, with the Rajasthan oil output priced at a 8-13% discount to Brent, in USD.
• The rupee weakening against USD is also beneficial to Cairn, as it earns higher INR for the oil.
• The recent decision to double natural gas prices to $8.4 per mBtu will also be beneficial to Cairn.

Pricing Snapshot 

Fig 3 Price History, JainMatrix Investments

The available 6-year view of the share price of Cairn Fig 3 shows us:

• The IPO of Cairn was in Dec 2006; it was subscribed 1.14 times and got a listing price of Rs 160.
• Since then, Cairn has given investors 10.5% returns CAGR to date.
• Given its pioneering status, Cairn has seen a high level of interest. The pricing low was 88 in 2008, and the high 401 in Mar 2012, post the Vedanta takeover. Its fallen by 27% since then.

Financial Snapshot

Fig 4 – Consolidated Financials Snapshot, JainMatrix Investments

• Significant Oil revenues at Cairn actually only began in FY10. It has ramped up in the last 3 years, with the resolution of issues with State Governments, ONGC and Petroleum Ministry.
• In line with this, the P/E (ttm) has rapidly fallen from 53 times (FY10) to 4.6 times currently. Fig 4.
• At current levels of Revenue 17,524 cr, Cash Flow is 11,000 cr. The business is very lucrative in terms of cash flow, with low operating costs and investments. Current cash on the books at 16,713 cr is at Rs 87 per share. The firm is debt free.
• For last 4 years, Operating and Profit margins are excellent at 69%, and 65% on average.
• Dividend declared for FY13 is 115% or Rs 11.5 per share, giving a current dividend yield of 4%.
• PEG based on 1 year projection is at 0.2 – indicates very undervalued stock.

Opportunities and Concerns

Strengths and Opportunities

• India is oil deficit, and imports 70% of its oil, priced in US dollars. This has caused stress in India’s Current Account Deficit CAD. In these circumstances, Cairn is a very valuable firm, as it helps save import costs. It has had very good success rates at oil exploration.
• The Rajasthan oil fields are expected to have a 23% growth in 1 year, and up to 71% in the next 3-4 years. In addition, the other Indian, Sri Lankan and South African oil fields have potential.
• The Mangala development pipeline is being extended by 80 km up to a sea terminal at Bhogat in Gujarat. This will allow Cairn to sell to any of the coastal refiners for better margins.
• The Promoter is Vedanta Resources plc is a diversified natural resources group with US$ 11 billion revenues. This provides stability and strength to business operations.
• In India, Oil & Gas exploration, discovery and production has had a very poor record. ONGC has a poor record, and the private sector so far has not had a very free hand in terms of opportunities and incentives. In this scenario, if Cairn is able to expand its operations and continue on the current path, it can taste great success.
• The major concern is how to use the large cash balance well. The firm has announced a USD 3 billion (Rs 16,500 crore) investment plan for the next 3 years to drill more than 450 wells in Rajasthan block, (increased from 25 wells drilled in FY2013). The wells planned include 100 exploration and appraisal wells, while balance will be development wells to sustain / enhance production volumes.

Risks and Concerns

• Oil exploration and production is an inherently risky and unpredictable business. The BP /Gulf of Mexico oil spill of 2010 shows that disaster can strike suddenly, causing business losses.
• Risk is also high in terms of the oil discovery to production cycle, which can take years of evaluation and studies. Oil Reserves can be ‘Proved’, ‘Probable’ and ‘Possible’.
• Unpredictable govt. regulations and unclear subsidy/ revenue sharing with govt. can be a risk with this firm.
• It has to be seen if Vedanta can continue on the pioneering path established by Cairn UK of successful exploration to oil production. A different skill set is needed at this stage for Cairn to negotiate effectively with government agencies, establish production infrastructure and compete effectively with rivals like Reliance.
• New Promoter: Today Cairn is a high revenue, profitable, ‘Cash Cow’ type of firm. We need to see if the new Promoters respect the firm’s independence, reward shareholders for business performance and continue on the path of good corporate governance.

Opinion, Outlook and Recommendation

• Oil consumption in India is in a very steady growth path, of 6-8% for the foreseeable future. The demand flows from transportation – vehicles, railways, airlines, shipping, and oil as fuel for factories, gensets, motors, tractors and infrastructure/ equipments/ agriculture.
• With significant oil production, visible growth potential, many new discoveries moving into production, as well as production and exploration agreements in place with the regulator, Cairn is a valuable, cash rich oil stock.
• At 4.6 times, the current P/E of Cairn puts it at a significant discount to most other Oil and Gas sector firms in India. It is a underpriced Value Stock. Valuations are attractive at these levels.
• The maiden dividend awarded this year is 115%. With cash flow and profitability high, and production likely to grow, investors can expect to gain in terms of shareholder rewards.
• Investors can buy Cairn at these price levels.

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