Hold Cairn India: Ask Securities

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Ask Securities has recommended hold rating on Cairn India . Research firm believes that Cairn India at Rs 145 is fairly valued.

Ask Securities report on Cairn India:

Investment highlights

Five fold increase in production from CY10:

Cairn India (CIL) has lined-up Rs 66 billion capex for the development of Rajasthan fields. We expect overall production to increase more than five fold to around 115,000 bopd in 2010. Cash flows from the Rajasthan production are expected to contribute Rs 53 per share (37%) to our fair value.

Reserve upsides contribute Rs 73 per share:

CIL's P2 reserve numbers of 472 mboe is based on a recovery factor of 32.5%. We expect the company to extend its high operational efficiency at Ravva and the Cambay basins to Rajasthan resulting in improved recovery and additional 386 mboe reserve upside. This accounts for Rs 73 per share of our fair value.

Investment concerns

Higher cess can significantly impact CIL's fair value:

We believe CIL would be liable for cess to the government. The risk lies in whether the cess would be applicable at USD 2.9/bbl (our assumption) or USD 8/bbl. At USD 8/bbl, Rs 14 is shaved off our base case fair value of Rs 145.

Key issues like pipeline and refinery can impact CIL's cash flows:

Issues pertaining to pipeline cost recovery and refinery at Rajasthan, being debated by the government, carry a significant risk of CIL's production at Rajasthan being delayed or trimmed. Other concerns like waxy nature of crude oil from Rajasthan, volatility in international crude price and exchange rates can have a major impact on CIL's cash flows.

Five fold increase in production from CY10

Rajasthan blocks to generate 85% of production in CY10:

CIL has lined-up Rs 66 billion capex for the development of the Rajasthan fields. The company would first develop the Mangala field, wherein we expect an initial production of 63,000 bopd (net to Cairn) from 2Q CY09E. In CY10E, we expect Bhagyam and Aishwarya fields to start contributing to overall production and expect the total production from Rajasthan to be at 87,000 bopd (85% of overall production) by CY10. This would raise the overall production by more than 5x to around 115,000 bopd in 2010

Funding the USD 2 billion capex for Rajasthan not an issue:

CIL would be undertaking an overall capex of around Rs 65 billion (USD 1.6 billion, net to CIL) for the development of the prospective Mangala, Bhagyam and Aishwarya fields (capex spread over the life of the field). This capex is in addition to USD 680 million already spent on the Rajasthan block till end 2006. The capex for the development of Mangala field alone would be around Rs 48 billion (USD 1.2 billion) and the rest is divided among the Bhagyam and Aishwarya fields. If CIL gets the mandate for laying the pipeline, another USD 350 million (net to Cairn) would be added to the above capex figure, which we have factored in our calculations. To fund this capex, the company has obtained debt facility of around USD 850 million. This, in addition to the IPO proceeds of around USD 600 million and internal accruals, puts CIL in a comfortable position for funding.

Attractive terms for production sharing contract:

CIL's production sharing contract (PSC) with the government for the Rajasthan block gives a 30% working interest to the government's nominee (i.e. ONGC), with CIL holding the rest (70%). The entire production from the Rajasthan fields would be sold to ONGC/MRPL in the above case. Another positive is that CIL would be eligible for a tax holiday for the first seven years of its production. In addition to the above, ONGC would be paying royalty, annual area rental charges and license fees to the government. CIL would be realising international parity prices for the hydrocarbon produce, after adjusting for its nature and quality.

Valuations

Fully priced:

Our core asset value of CIL of Rs 72 per share is based on our sum-of-the-parts valuation (DCF value). Based on CIL's successful track record in India, we believe there exists an upside potential of Rs 73 per  share to its core asset value, considering a higher recovery factor for the Rajasthan fields. This figure can go up significantly based on further reserve accretion due to new discoveries from other exploration blocks. At our fair value of Rs 145 per share, we believe CIL is fairly valued. We initiate coverage with a Hold rating.

Core asset value at Rs 91:

We have used sum-of-the-parts valuation for the company, valuing its entire assets separately. Our DCF valuation generates EV/boe for the Rajasthan fields is USD 6.9, and is USD 6.8 for the company as a whole. This translates into a value of Rs 72 per share for the core assets of Cairn. Key assumptions for our calculations:

• WACC of 12.8%.
• Crude realisation for Rajasthan at 8-10% discount.
• OIDA cess of USD 2.9/bbl (Rs 900/tonne).
• Operating cost of production for Rajasthan at around USD 5/bbl.
  Long-term average for Brent at around USD 55/bbl.
• Average USD/INR exchange rate of Rs 40.