Street ignoring exploration upsides for Cairn India

Most analysts are bullish on the Cairn scrip with average target price of Rs 382.36, implying upsides of about 30 per cent from current levels of Rs 292.

The Cairn India (Cairn) stock has under-performed the Sensex as well as the BSE Oil and Gas Index, in the past few months. Concerns surrounding production ramp up at its Bhagyam and Mangala fields (in Rajasthan), alongwith deployment of its huge cash kitty of $2.7 billion (about Rs 14,800 crore), are key reasons for the stock’s decline since mid-January. However, current valuations appear to factor in these concerns adequately. Many brokerages, including Edelweiss Securities, ICICI Securites and Kotak Securities, have upgraded the stock to ‘Buy’ in the past couple of days citing cheap valuations and good business prospects.

“Cairn’s current price factors almost no exploration upsides (our estimate of Rs 77 per share). Its FY14 estimated price/earnings of 4.7 times is also attractive. Hence, we upgrade to ‘Buy’ from ‘Hold’,”  says Niraj Mansingka, oil and gas analyst at Edelweiss Securities. According to Bloomberg consensus, most analysts are bullish on the scrip, with an average target price of Rs 382.36, implying upsides of about 30 per cent from the current levels of Rs 292. Over the next three years, Cairn plans to drill about 100 exploratory wells,  which should add to its proven reserves and ease production ramp-up concerns.

“The recent approval by the government for exploration in producing assets paves the way for expansion of production from the Rajasthan block. Current valuations imply Brent crude at $85/barrel ($25/barrel discount to current prices). Additionally, dividend yield works out to be four per cent plus at current levels (at par with oil PSUs). We upgrade the stock to buy,” says Rohit Ahuja, analyst at ICICI Securities. A fall in crude oil prices and substantially lower-than-expected oil reserves recovery are the key risks. With commencing of oil production at its Aishwarya field in Rajasthan (started last month), higher production from Bhagyam field, the management expects to scale up production from 170,000 barrels per day (bpd) currently to 200,000-215,000 bpd by March 2014 (analysts expect production from Mangala and Bhagyam to be about 150,000 bpd and 40,000 bpd respectively in FY15).

The Street has also been watching for management indication on efficient utilisation of its cash kitty. While higher cash generation augurs well for Cairn’s exploratory activities, analysts believe a good acquisition or buy back of shares will be a significant positive.

“We believe the time is opportune for a share buyback as it will be tax-efficient and value-accretive for shareholders. A 10 per cent buyback will boost FY15 estimated earnings per share by 7.7 per cent and also raise promoter holding by 6.5 per cent,” says Mansingka. Netting off the capex of $2 billion over the next two years, as well as the 20 per cent dividend pay out, analysts expect Cairn to generate free cash flows of about Rs 10,000 crore annually over FY13-15.