Reserve upgrades key for Cairn India

While production ramp-up at the Rajasthan block may take some time, approvals to drill new wells leading to reserve upgrades will provide impetus to the stock, say analysts

Cairn India Ltd reported expected numbers for the quarter ended December 31, though partly boosted by foreign exchange (forex) gains, lower taxes and one-offs. Though the street’s concerns on Cairn’s oil transportation pipeline (running from Rajasthan to west coast) have been addressed, with the management observing that the pipeline is now able to carry 200,000 bopd (barrels of oil equivalent per day), the concern over oil output at its prolific Rajasthan block remains.

Gross oil production from the Rajasthan block, though up 38 per cent year-on-year (y-o-y), was flat at 170,000 bopd sequentially for the December quarter. With a production ramp-up at Bhagyam oil fields (a part of the Rajasthan block) still a few quarters away due to complexities in the reservoirs, it could prove to be an overhang on the stock. Not surprisingly, after opening with gains, Cairn’s stock closed 2.25 per cent lower at Rs 332.65 today on BSE, while the benchmark Sensex shed 0.60 per cent at 19,981.57 points.

Positively, in the longer run, analysts are looking at reserve upgrades to provide fresh triggers for the stock. On this front, the government has cleared incremental exploration activities and Cairn is expecting to drill as many as 100 new wells over three years in the Rajasthan block. Thus, majority of analysts remain positive on the stock – conservative analysts have price targets of up to Rs 377 levels, while optimistic ones have Rs 400 plus target. Bloomberg consensus target at Rs 385 indicates potential upside of 14 per cent from the current levels of Rs 336.

MUTED SHOW IN FY14
In Rs crore	Q3’FY13	FY13E	FY14E
Net sales	4,278	17,438	21,545
% change y-o-y	38.1	33.0	23.6
Ebitda	3,259	13,399	14,572
Ebitda (%)	76.2	76.8	67.6
Net profit	3,345	11,793	11,886
% change y-o-y	47.9	34.6	0.8
EPS (Rs)	-	64.3	62.1
PE (x)	-	5.2	5.4
E: Estimates Consolidated financials Source: Elara Capital

Q3: One-offs boost profits
With net crude oil realisations were marginally down (both y-o-y and sequentially) at $95.6 (Rs 5,135) per barrel for output from the Rajasthan block, Cairn still managed to report a 38 per cent y-o-y jump in revenues due to higher production – sequentially though sales and production were almost flat. The company’s Ebitda (earnings before interest, taxes, depreciation, and amortisation) margin, though, remained flat aided by Cairn’s low operating costs.

At the net level, forex gains of Rs 236 core were lower than Rs 300 crore in the year-ago period, but in contrast with the Rs 786-crore loss in the September 2012 quarter. Nevertheless, a 62 per cent rise in other income to Rs 182 crore, lower interest costs, a 73 per cent fall in tax outgo to Rs 32 crore and an exceptional gain of Rs 189 crore helped profits surge 48 per cent y-o-y and 44 per cent sequentially. Over the long term, though, analysts expect tax rates to inch up.

Output increase in FY14
Aishwarya, Mangala, Bhagyam and Barmer Hills fields form a part of Cairn’s Rajasthan block. While output from Mangala fields continues at its peak level of 150,000 bopd, output from Bhagyam field at around 20,000 bopd has still not been ramped up to 40,000 bopd due to reservoir complexities. Bhagyam fields may take some time for ramp-up as more wells need to be drilled. Aishwarya field is likely to start producing 10,000 bopd by end-FY13. Given the management’s guidance and with Bhagyam field expected to produce 40,000 bopd only by the second half of FY14, Cairn targets exiting FY14 with a production at 215,000 bopd.

Reserve upgrades are crucial
Currently, more than 95 per cent of Cairn’s stock valuations are accounted for by its Rajasthan reserves, according to analysts at HSBC. With the government allowing more exploration activities in the block, Cairn is expected to drill more wells, which will be drilled at various targeted location as well as those in the Barmer Hills that hold maximum promises. Analysts at Citi observe that the management sounded extremely enthused by the government’s recent approval allowing exploration activities to be carried out in the assets under development with cost recovery assured, and plans to submit an exploration work programme shortly.

Analysts at HSBC believe significant reserves upside is likely over the next one-two years. Their analysis indicates that the in-place oil volume can potentially more than double from the current guidance of 7 billion barrels of oil equivalent. This is on account of upsides from the top layer called Barmer formation, which is similar to shale oil and additional geological feature that are yet to be fully explored. They expect a risk-adjusted reserves upside of around 40 per cent as a result. Alok Deshpandey at Elara Capital, though, believes a strong valuation upside above Rs 360 can come only from reserves upgrade in other fields in Rajasthan and till then, he expects a range-bound performance between Rs 320-350 for Cairn’s stock for another two quarters.