Fresh impetus for Cairn India

With royalty sharing priced in, capacity expansion will be trigger, higher crude oil prices and rupee fall being icing on the cake.

Cairn India’s stock had hit a 52-week low of Rs 250 on August 26 after its erstwhile parent (Cairn Energy Plc of the UK) made a U-turn and accepted all government conditions to get clearance for its stake sale (in Cairn India) deal with the Vedanta group. The shocker that Cairn had to share royalties with Oil and Natural Gas Corporation, as well as pay cess, hit investor sentiment and pushed the stock down. Cairn India took pro-active measures immediately. It made provision for cost-recoverability of royalty for prior periods in the September quarter itself, paving the way for future profitability.

With this and Vedanta having completed the acquisition of a controlling stake in Cairn India, the attention returns to fundamentals. The company, which has production approvals of 175,000 barrels of oil equivalent a day (bopd), is looking at further ramp-up. Analysts say this will have a positive rub-off on the stock, leading to an upgrade in earnings. Additionally, higher crude oil prices and dollar-denominated pricing are, thanks to the rupee’s fall, also benefiting the company. Most analysts are positive on the stock (now at Rs 310), which has been outperforming the broader markets since the start of last month.

With royalty becoming cost-recoverable and Cairn having to pay back its share of subsidy born by ONGC in FY10 and FY11, the September quarter saw the company take a one-time hit of $294 million as it accounted for these. While the move led the quarter’s earnings, at Rs 763 crore, to decline 72 per cent sequentially and 52 per cent compared to September 2010 quarter, it has cleared the way for future profitability, beside allowing it to focus on growing its core business.

FOREX, CRUDE OIL GAINS IN FY12
Rs  crore	FY2011	FY2012E	FY2013E
Brent crude oil ($/barrel)	87	112	90
Rs /$ exchange rate (Rs )	46	48	45
Net sales	10,277	16,757	16,612
% change	533.3	63.0	-0.8
Ebitda	8,523	11,516	10,483
% change	1,004	35.1	-8.9
Net profit	6334.0	8279.0	7741.0
% change	579.2	41.2	-6.4
EPS (Rs )	33.3	43.5	40.7
PE (x)	9.2	7.0	7.5
E: Estimates                         Source: Capitaline, HSBC Global search

Capacity expansion key
Cairn India’s Rajasthan block had stable production of 125,251 bopd during the September quarter. It already has approval for producing 175,000 bopd (125,000 from the Mangala fields, 40,000 from Bhagyam and 10,000 from the Aishwarya fields). Mangala’s are operating at optimum capacity and the management expects to start production from Bhagyam soon, followed by Aishwarya, thereby attaining 175,000 bopd output by March 2012.

Arindam Pal at Asian Market Securities says the Mangala field’s production can be ramped up to 150,000 bopd easily, as no Field Development Plan (FDP) requires to be filed for this. Thus, scaling up to 2,00,000 bopd by the end of 2011-12 looks achievable. The approvals for expanding capacity further should fall in place by then, feel analysts. While the Rajasthan block has long-term potential for producing more than 300,000 bopd, the management expects 240,000 bopd in 2012-13.

Probal Sen from IDFC Securities says approvals for output expansion will be expedited, as conditions on the takeover deal have been accepted, adding that operational improvements will help offset the loss of value from higher costs due to the royalty change over the longer term.

The company is poised to develop the second wave of exploratory upsides on the Rajasthan asset from 2012-13, which will drive growth. Analysts at HSBC Securities say the new promoters (Vedanta) will support Cairn India’s endeavours, as they have done with their previous acquisitions. They add that after resolution of royalty, the relation between ONGC and Cairn has improved and the former is also likely to support capacity expansion.

Higher prices, lower rupee
Meanwhile, crude oil prices show no signs of cooling in the near term. On the other hand, the rupee’s value vis-a-vis the dollar is falling regularly. Various analysts are, thus, upgrading their FY12 average crude oil price expectations from $110 to $112 and the dollar-rupee rate from Rs 45 to Rs 48. Consequently, Cairn’s FY12 estimates are being revised upwards. For instance, analysts at HSBC Global Research have, in their report, upgraded their earnings estimates for Cairn for 2011-12 from Rs 43.56 in October to Rs 44.04 lately.

However, most analysts are keeping 2012-13 estimates unchanged for now and say that based on oil prices and exchange rates in the March quarter, the 2012-13 estimates will be reworked, most likely upwards. Analysts at IDBI Capital add that with the upward revision in crude oil price and the rupee-dollar exchange, Cairn India is set to benefit the most among all oil companies.