Cairn India – Express Idea

CMP Rs341, Target Rs380, Upside 11.5%

Cairn a direct beneficiary of high crude prices and weak rupee

Cairn India is a pure play on crude oil prices with operating margins of 80% and net margins of 60%. Any rise in crude oil prices directly flows to the bottom line. Furthermore, a weak INR helps profitability as the refiners are billed in USD. For every, US$5/bbl rise in crude prices Cairn’s EPS for FY13 will rise by 5.4%, while every Re1/US$ depreciation in INR EPS increases by 1.8%.

More upsides for crude price

On the backdrop of a global slowdown, the demand for crude oil has been weak. Nevertheless, economies across the world through stimulus measures are trying to rev up the growth. Both Euro Zone and US have already announced measures to stimulate their economies. China too has been cutting interest rates and is planning to implement a few more stimulating measures. In such a scenario, the demand for crude oil will see an immediate bump up while supply will take time to catch up leading to spurt in crude prices.

Approvals for higher production will be the next trigger

Current production from the Cairn operated Rajsthan field is ~175,000bopd. The company has filed for various approvals to increase the production further. With Bhagyam production lower than the company’s guidance, the government has apprehensions for giving further approvals. However, over the medium term, we expect the government to give approvals considering the rising imports of crude oil and its impact on the trade deficit.

Attractive valuations, maiden dividend keenly awaited

Cairn India currently trades at a P/E of 6x on FY14E EPS of Rs57.1. This is based on a production estimate of 200,000bopd in FY14, crude oil realization of US$95/bbl and Rs/US$ estimate of 53. Factoring in current crude price and exchange rate valuation attractiveness will only increase. With cash balance of Rs70bn at the end of FY12 and expected cash flow generation of Rs55bn in FY13, investors are anticipating a high maiden dividend payout. The announcement is expected as soon as the internal restructuring of the new management is done with.