Cairn India: Reserve upgrades in FY14 to provide fresh trigger

The company's stock ended 1.5% lower at Rs 289 on Tuesday, later bounced back to Touch Rs 306 levels

After a knee-jerk reaction after results that saw Cairn India’s stock end 1.5 per cent lower at Rs 289 last Tuesday, it has bounced back to touch Rs 306. The market would have been disappointed with no immediate upside in production visible from the prolific Rajasthan block. However, the company gave a strong guidance for exiting FY14 at production levels of 200,000-215,000 barrels of oil per day (bpd), against current production levels of 175,000 bpd. It sees the Mangala fields in the Rajasthan block to maintain production of 150,000 bpd. The Bhagyam field (currently producing 25,000 bpd) should also reach 40,000 bpd in the second half of FY14, while the Aishwariya field that started production in March 2013 should see oil production reaching 10,000 bpd; balance from Barmer Hill (field development plan approval is still awaited). However, what’s more important is there is high potential of the company’s oil reserves being upgraded in the next two-three quarters led by higher exploration and drilling activities, which in turn will provide further triggers for the stock.

The estimate has allayed some fears of investors on declining production from the Mangala fields. The management expects plateau production to be sustained at the current 150,000 bpd level through FY14 with the help of drilling of 48 infill wells, approvals for which are at an advanced stage. Commencement of enhanced oil recovery should support output thereafter, add analysts at Citi.

Analysts, though, remain divided on the company’s ability to exit at the guided levels. Analysts at HSBC expect production to remain flat over FY14 and increase only moderately close to FY14-end due to lead time required for various approvals. They continue to maintain that a quick ramp-up of production is unlikely, given the waxy nature of crude oil and flow property variation of the reservoir. However, analysts at Morgan Stanley believe guidance was in line with the 210,000 bpd they have currently assumed. “Cairn no longer gives production guidance by field, but with the ramp-up at Bhagyam, Aishwariya, start-up of Barmer Hill and infill wells planned in its Mangala field, we believe this is achievable,” they say.

Nevertheless, analysts at both the research houses like many others remain ‘overweight’ on Cairn and are banking more on reserve upgrades rather than the production ramp-up. With the government approval for additional exploration in place, the company is targeting several prospects identified but not yet drilled. Thus, analysts at HSBC believe significant reserve upside is likely over the next one to two years. Their analysis indicates an in-place oil volume can potentially more than double from the current guidance of seven billion barrels of oil equivalent on account of upside from the top layer called the Barmer formation, which is similar to shale oil, and additional geological features that are yet to be fully explored. “We expect a risk-adjusted reserves upside of 40 per cent as a result,” they add.

Cairn has allocated $3 billion over the next three years for drilling activities ($1 billion a year). A majority is for tapping the Rajasthan block as Cairn plans drilling 450 wells, including 100 exploration wells.

Alok Deshpande at Elara Capital expects the stock to deliver 13-15 per cent returns over the next 18-24 months, driven by reserve upgrades rather than production guidance upticks. While Deshpande has a target price for the stock at Rs 330, analysts at HSBC have a target price of Rs 400; according to Bloomberg, the consensus target price is Rs 374.

Meanwhile, the company had reported profits of Rs 2,564 crore (up 17.3 per cent year-on-year). The profits could have been higher had Cairn not written off Rs 366 crore worth of exploration expenses, including Rs 260 crore towards a Sri Lankan block and Rs 7.3 crore towards the completion of 80 per cent of 3-D seismic survey in a South African block.

Going ahead, while there could be near-term pressure on oil production, Cairn’s realisation will get a boost from the reducing discount on the oil it produces. The discount has fallen from 12.5 per cent to Brent crude oil price in the December 2012 quarter to 10.7 per cent in the March 2013 quarter. Based on the new contracts concluded, the discount to Brent will be 8-13 per cent versus 10-15 per cent currently, which will boost profitability for Cairn.

RISING LEVELS
 
* Cairn expects to end FY14 with a production level of 200,000-215,000 barrels of oil a day against 175,000 currently

* The company has allocated $3 billion over the next three years for drilling activities, mostly for tapping the Rajasthan block

* Falling discount on the oil it produces to Brent would boost profit. Under new contracts, the discount to Brent crude oil would be 8-13 per cent against 10-15 per cent now