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Cairn India – Stock of the Month (November 2014)

10 October, 2014

Price: Rs. 287.50

Cairn India Limited (“Cairn India” or the “Company”) is one of the largest oil and gas exploration and production companies in India and is engaged in various related businesses including exploring, refining, trading, transporting and marketing of oil and gas. The Company also deals in minerals and oil and gas related by-products. Cairn India’s producing assets are in Rajasthan, Cambay (Gujarat) and Ravva (Andhra Pradesh).

The Company has a total of 10 blocks/fields in its portfolio. The Company is participant in various oil and gas blocks/fields (which are in the nature of jointly controlled assets), granted by the Government of India through production sharing contracts.

INVESTMENT RATIONALE

Strong Financial Position

Cairn India has shown consistent growth over the last five years (i.e. 2009-10 to 2013-14). Its net revenue from operations over this period grew at an impressive CAGR of 84.39%. For FY 2014, income from operations increased by 7.06 % to Rs. 18,761.70 Cr. from Rs. 17,524.15 Cr. and EBITDA increased by 5.01 % to Rs. 13,685.72 Cr. from Rs. 13,033.16 Cr. The Company has reserves in excess of Rs. 55,530.10 Cr and OPERATES WITH ZERO DEBT on its books. This strong financial position has enabled the Company to expand its operation in a subdued economic environment.

Cairn India financial performance

 At CMP of Rs. 322.75 (24th July, 2014), Cairn India is trading at a P/E of 8.39x and has a dividend yield of 3.5% at current market price.  This we believe makes Cairn India as one of the best long term stocks in the current market scenario.

Promoters hiking stake

On 23rd January 2014, the Company commenced a buyback of its equity shares at a price not exceeding Rs. 335 per equity share for an aggregate amount not exceeding Rs. 5,725.00 Cr.  The buyback issue closed on 22 July 2014. During the Buyback period, the Company bought back 36,703,839 shares for a total consideration of approximately Rs. 1,225 Cr. from the open market through stock exchanges.

An increase in promoter stake is a strong reaffirmation by the insiders, who are the first recipient of any information and knowledge, that there is greater potential value in the business than what the market is paying for it.

Expansion Plan

Cairn India has started implementation of three major development projects in the Rajasthan block – (i) Polymer Flood Enhanced Oil Recovery (EOR), (ii) Barmer Hill (BH) development; and (ii) a gas development project. Gas potential in the Rajasthan block presents a unique opportunity for Cairn India to establish itself as a key player in the Indian natural gas market. The Company plans to make an investment of US$ 3 billion over the next three years i.e. FY 2015-17. This expansion is expected to deliver a growth of 7 % to 10 % in production over the next three years.

On the back of this expansion plan, in our analysis. Cairn India is well positioned to grow its revenues and profits over the next few years.

Government reforms in petroleum product pricing

The new NDA led government has shown both intent and commitment towards reforms in the oil and gas sector. Any reforms in the  sector and any future price hikes in petroleum products like diesel, LPG and kerosene would add significantly to Cairn’s earnings.

INVESTMENT CONCERNS

Risks Related to Execution of Projects

Cairn India’s expansion projects have long execution timelines with interdependencies. To successfully execute the project, the Company has to rely on multiple equipment and services providers and construction contractors across sites spread over a wide geographic area. Ensuring timely delivery of such services and equipment at the right cost, managing materials at remote sites, while simultaneously ensuring that all compliances are met can pose potential challenges.

Any delay in the commissioning of projects is a concern for the Company as it leads to delay in inflow of revenues. At the same time, company has to incur costs on the delayed projects, thus affecting margins and overall profitability which could have a negative impact on the share price.

Regulatory Policy

The Company’s business will be affected by the changing regulatory policies such as any political developments by the central, state, local laws and regulations such as production restrictions, changes in taxes, royalties and other amounts payable to the various governments or their agencies. Any adverse political developments, laws and adverse changes in the regulatory environment will naturally have a negative impact on the overall profitability of the Company.

Currency Fluctuation – Appreciation of Rupee against the US $

Cairn India remains exposed to the risk of foreign currency fluctuations. Foreign Exchange markets continue to be volatile and have witnessed severe movements in both directions over the last few years. The Company’s realizations are denominated in U.S. Dollar terms and thus it remains exposed to the risk of rupee appreciation vs. the U.S. Dollar.