UBS Investment is bearish on Cairn India and has maintained sell rating on the stock with target price of Rs 169.

UBS Investment research report on Cairn India

Downgrading to Sell on valuation

Share price strong recently

Since July 2007, the stock has risen c25% whereas the BSE Sensex has risen c9%. We maintain our PT of Rs169 and are downgrading our rating to Sell (from Neutral) on valuation grounds.

Stock price factors in long-term crude price of USD 54/bbl

Assuming CIL is unable to add to its hydrocarbon reserves or increase recovery rates from Rajasthan (beyond EOR), we believe the potential risks are to the downside. In our view the stock, at current prices, is discounting a long-term Brent crude price of cUSD 54/bbl against a UBS forecast of $50/bbl. In our opinion, any further upside to our valuation is likely only in the event of significant successes in CIL’s exploration programme. 

Rajasthan block accounts for 92% of our price target

With proved-plus-probable reserves of 632m bbl, CIL’s Rajasthan block accounts for 93% of net 2P recoverable reserves and 92% of our price target. We estimate CIL’s oil and gas production could grow at a CAGR of 48% over 2006-10. The Rajasthan block is scheduled to start production in 2009. We expect the evacuation pipeline to be ready by March 2009.

Valuation: Downgrade to Sell on valuation; reiterate PT of Rs169

Our price target of Rs169 is based on our NAV estimate for Cairn India’s E&P assets. We value CIL’s stake in the Rajasthan, Ravva and Cambay blocks using a DCF methodology (WACC 11.1%). For the remainder of its assets we use EV/boe. We factor in exploration upside by valuing a risk-adjusted 360m bbl of prospective resources.  The Rajasthan block accounts for 93% of the 2P recoverable reserves of the firm.

Hence we believe the NAV of its assets is the best way to value CIL. We use DCF to estimate the NAV of the Rajasthan block, Ravva field and the Cambay block. At our target price the stock would trade at a PER of 6.7x FY10E earnings. CIL believes EOR using AS (Alkali Surfactant) could possibly increase the recovery rate by as much as a further 15% of oil-in-place, taking the overall recovery factor at the MBA fields in Rajasthan to 60%.

This remains a higherrisk approach, in our opinion; therefore, while we recognise this potential value accretion, we risk-weight this potential upside at 40%. We also risk-weight the potential upside from CIL’s exploration prospects at 20%. Exploration prospects are likely accretive to reserves, based on further exploration by the company in its blocks.