3 Cairn India Ltd - Company Report VIOLET ARCH Securities Pvt. Ltd. (Erstwhile Alchemy Share & Stock Brokers Pvt. Ltd.) COMPANY REPORT Cairn India Ltd. Operation Desert Storm Equity Research l Oil & gas April 5, 2013 We initiate coverage on Cairn India Ltd. (CIL) with a BUY rating. CIL is one of the best stock plays in India to have direct exposure to global crude prices. With its world-class Rajasthan Block already under production, the company has joined the big league of players in India’s E&P space. Rajasthan Block’s Gross Hydrocarbons Initially In Place (GHIIP) is 7.3bnboe, of which estimated recoverable reserves stand at 1.7bnboe. In two years production from Rajasthan Block is expected to reach 210,000bopd from the current 170,000bopd, which will contribute around 30% of India’s domestic crude production. With world-class oil production assets, exciting E&P prospects and highly competent management, coupled with high crude prices, CIL stock is an attractive investment option. Investment Argument Resource-rich Rajasthan fields CIL’s GHIIP in Rajasthan Block stands at 7.3bnboe, with the expected ultimate recovery of about 1.7bnboe. MBA (Mangala, Bhagyam and Aishwarya,) fields in Rajasthan Block have reserves of around 2.1bnboe, of which 2P reserves are estimated at 1.0bnboe, representing a recovery factor of 48%. Additionally, CIL has estimated recoverable resources of around 165mmboe from the Barmer Hill formation and other discoveries and another 530mmboe from the exploration upside. With the approval from government for resume exploration activities in Rajasthan block (after a gap of four years), Cairn has already embarked upon a 3-year exploration programme to drill over 100 exploratory/appraisal wells. Rajasthan Block production to rise by 22% by end of FY15 CIL is poised to achieve production of 210,000bopd from Rajasthan Block from the current 175,000bopd on the back of sustained production of 150,000bopd from Mangala along-with EOR (Enhanced Oil Recovery) implementation, ramp-up of Bhagyam to 40,000bopd and peak output of 20,000bopd from Aishwarya. A strong output ramp-up, along with high crude prices, will ensure healthy growth in cash-flows for the company. Valuation At the CMP of Rs 288, the stock trades at P/E, EV/EBITDA and P/BV of 5.5x, 2.7x and 0.8x, respectively, on FY14E estimates of EPS, EBITDA and BV. Since the production has begun from MBA fields, the stock has averaged at 7.8x one-year forward earnings. We value MBA fields on a NAV basis and other recoverable reserves on an EV/boe basis to arrive at a target price of Rs 374, which reflects an EV/boe of $9.5/bbl. We initiate coverage on Cairn India with a BUY rating. CIL valuation Block Net 2P/ Recoverable Reserves (mmbbl) Rs/share (USD/boe) MBA + EOR 620 206 12.9 Barmer Hill 116 15 5.2 Exploration Upside Potential 371 49 5.2 Ravva 14 3 9.1 Cambay 4 1 9.1 Total 1,125 275 9.5 Net debt - 99 - Cairn India - 374 - Particulars FY12 FY13E FY14E FY15E Revenue (Rs bn) 118.6 176.0 170.4 164.7 Growth (Y-o-Y) 15.4% 48.4% -3.2% -3.4% EBIDTA (Rs bn) 91.5 131.8 122.1 111.3 EBIDTA margins 77.2% 62.5% 58.9% 55.5% PAT (Rs bn) 79.4 115.1 99.4 85.2 PAT margins 66.9% 54.6% 47.9% 42.5% EPS 41.6 60.4 52.1 44.6 P/E (x) 6.7 4.6 5.4 6.3 EV/EBIDTA (x) 5.2 2.8 2.6 2.4 Source: Company, Violet Arch Research Stock data CMP Rs 288 Reuters Code CAIL.BO Bloomberg Code CAIR IN Equity Shares o/s (mn) 1,908 Market Cap (Rs mn) 534,160 Market Cap (USD mn) 9,891 Stock performance (%) 52-week high / low Rs 366/283 1M 3M 12M Absolute (10.6) (13.9) (20.2) Relative (8.1) (11.4) (28.0) Shareholding pattern (%) Relative stock movement Promoter, 59 Public & others, 16 FII, 15 DII, 10 80 85 90 95 100 105 110 115 120 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Cairn India Ltd Sensex Absolute Rating BUY Target Price Rs 374 Upside 30%
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We initiate coverage on Cairn India Ltd. (CIL) with a BUY rating. CIL is one of the best stock plays in India to have direct exposure to global crude prices. With its world-class Rajasthan Block already under production, the company has joined the big league of players in India’s E&P space. Rajasthan Block’s Gross Hydrocarbons Initially In Place (GHIIP) is 7.3bnboe, of which estimated recoverable reserves stand at 1.7bnboe. In two years production from Rajasthan Block is expected to reach 210,000bopd from the current 170,000bopd, which will contribute around 30% of India’s domestic crude production. With world-class oil production assets, exciting E&P prospects and highly competent management, coupled with high crude prices, CIL stock is an attractive investment option.
Investment Argument Resource-rich Rajasthan fields CIL’s GHIIP in Rajasthan Block stands at 7.3bnboe, with the expected ultimate recovery of about 1.7bnboe. MBA (Mangala, Bhagyam and Aishwarya,) fields in Rajasthan Block have reserves of around 2.1bnboe, of which 2P reserves are estimated at 1.0bnboe, representing a recovery factor of 48%. Additionally, CIL has estimated recoverable resources of around 165mmboe from the Barmer Hill formation and other discoveries and another 530mmboe from the exploration upside. With the approval from government for resume exploration activities in Rajasthan block (after a gap of four years), Cairn has already embarked upon a 3-year exploration programme to drill over 100 exploratory/appraisal wells.
Rajasthan Block production to rise by 22% by end of FY15 CIL is poised to achieve production of 210,000bopd from Rajasthan Block from the current 175,000bopd on the back of sustained production of 150,000bopd from Mangala along-with EOR (Enhanced Oil Recovery) implementation, ramp-up of Bhagyam to 40,000bopd and peak output of 20,000bopd from Aishwarya. A strong output ramp-up, along with high crude prices, will ensure healthy growth in cash-flows for the company.
Valuation At the CMP of Rs 288, the stock trades at P/E, EV/EBITDA and P/BV of 5.5x, 2.7x and 0.8x, respectively, on FY14E estimates of EPS, EBITDA and BV. Since the production has begun from MBA fields, the stock has averaged at 7.8x one-year forward earnings. We value MBA fields on a NAV basis and other recoverable reserves on an EV/boe basis to arrive at a target price of Rs 374, which reflects an EV/boe of $9.5/bbl. We initiate coverage on Cairn India with a BUY rating.
1) World class asset 'Rajasthan Block' with GHIIP at around 7.3bnboe and recoverable reserves at about 1.7bnboe.
2) Low cost of production with direct field opex and pipeline opex at $3.5/bbl and $1.5/bbl.
3) Strong balance sheet with cash in hand at Rs 140bn as of 31st Dec'12.
4) Superior execution capabilities as seen in the case of Rajasthan block, Ravva and Cambay.
Weaknesses
1) As of now, Cairn is considered a single asset player, as majority of its production is expected from Rajasthan Block in the near term.
2) Being mature fileds, Cambay and Ravva production on decline.
Opportunities
1)The Barmer Hill formation reserves recovery factor at around 8%. Reserves of similar nature has had recovery factors of up to 20%.
2) Further exploratory efforts could lead to upgradation of 2P reserves in Rajasthan Block.
3) 10 exploratory assets in three strategically focused areas: one in Rajasthan; three on the west coast of India; six on the east coast of India, including one in Sri Lanka.
Threats
1) Delay in approvals from the government could lead to delays in achieveing the production guidance in Rajasthan Block.
2) The government raising statutory levies impacting profitability of Cairn.
3) Falling crude prices leading to a fall in profits.
Geo-politics and crude Country Its role in geo-politics
US
US has recently established powerful sanctions that prevent Iran from receiving earnings to which it is entitled from its shrinking oil export trade. Under the new set of sanctions the Islamic regime has no choice but to continue with barter trades and local currencies, with limited access to the foreign exchange it desperately needs to continue its nuclear program and its customary support of international terrorism in the four corners of the world. Has been consistently mounting pressure on Iran and garnering support from EU for the same so that Iran comes to negotiation table. Though the shale oil production in US is increasing rapidly, it may not become completely import independent in the near future, which will mandate it to keep its influence over middle-east oil politics.
Israel Israel is strongly opposed to Iran going ahead with its nuclear ambitions. It has not ruled out military strike to bring Iran’s nuclear program to halt. Israel has full support of US when it comes to any conflict in Iran or Middle-East as well.
Iran
Declining oil exports has caused the Iranian rial to shed more than 60 percent of its value against the U.S. dollar, leading to spiraling inflation and mounting unemployment. Uncontrolled inflation has raised food and commodity prices to such a degree that the majority of Iranian citizens presently cannot afford even basic necessities. Super inflation and unemployment in Iran are now presenting a serious danger to the regime. the opportunity costs of the nuclear program has been at well over $100bn in terms of lost foreign investment and oil revenues. However, Iran is still not ready to give up on its nuclear ambitions.
Saudi Arabia
Saudi has a majority Sunni population while Iran has majority Shi’a population. Theocracy in Iran has openly challenged the legitimacy of the Royal House of Saud. Both harbor ambitions to become economic and political power in Middle-East. Saudi has made up for production losses due to sanctions on Iran. Saudi Arabia is the largest member of the OPEC and the only one with significant unused capacity to produce more. It reduced output in Dec’12 by 4.9 percent to 9.025mbpd, the lowest level in 19 months primarily to stabilize oil prices.
China
When it comes down to its foreign policies China follows its own interests without buckling down to any international pressure. Latest examples were the conflict between China and Japan for islands in South China sea. It has not also opposed North Korea’s war rhetoric. And with the change in leadership it is claiming Taiwan as part of China. Even in the case of Iran it has not opposed any sanctions on it and will not support any military actions against Iran. It has been getting oil from Iran at discount to international rates. However it is reducing its oil imports from Iran just to comply with international sanctions.
Russia
Russia wants to curtail western powers especially US hegemony in Middle-East. It never supported any sanctions or any military actions against Iran. Russia had also helped Iran in building a nuclear reactor. However, business interests are not the main drivers of its relationship with Iran. Russia is extremely dependent on energy exports, particularly on the export of crude oil. Russia robust state finances (Russia has by far the lowest debt/GDP ratio of any major country) are almost entirely due to its sizable exports of oil and natural gas. Thus any conflict in Middle-East which supports elevated crude prices will be beneficial to Russia.
Venezuela
Venezuela has the largest known oil reserves in the world, but oil output has slumped by almost a third because of Mr Chavez’s nationalization of the industry. The country holds 17.9% of the world’s known oil reserves, compared with 16.1% in Saudi Arabia and 10.6% in Canada. However, it only represented 3.5% of global production compared with 13.2% in Saudi Arabia. It is likely that oil output could rise, should there be an easing of the country’s antagonism to foreign investors. Some believe this could lead to a fall in the oil price and a consequent boost to the global economy. However, the state oil company PDVSA has increasingly been handing over its income to fund various government programmes, leaving it with negative cash flows for the past five years. The result of this has been a lack of investments as old fields matured and new ones were not explored, hence the drop in output. Consequently, for the output to rise from Venezuela will take much more time.
Sudan-South Sudan
South Sudan seceded from Sudan in July 2011. Along with this South Sudanese independence came 75% of Sudan’s oil resources—minus the infrastructure (pipelines and ports) which remains in Sudan. So South Sudan became now rich in oil which is land-locked. However recently, Sudan and South Sudan reached an agreement for the resumption of South Sudanese oil exports through Sudanese infrastructure. The deal calls for a withdrawal of troops from both Sudan and South Sudan and the creation of a demilitarized zone to facilitate the flow of oil. Oil hasn’t flowed for about a year after South Sudan blocked exports via Sudan over a tariff dispute.
Nigeria Oil production in Nigeria, Africa’s biggest producer, is down by about 1.0mbpd because of violence and theft in the Niger River delta. Currently, producing at 2.5mbpd, well below it’s capacity of 3.7mbpd.
North Korea - South Korea – US
North Korea has said that it had entered "a state of war" with South Korea in its latest threat aimed at the United States and its ally after two American B-2 bombers flew a training mission in the region. The situation on the peninsula is now more volatile, with the North controlled by a relatively new leader, Kim Jong Un, and the South Korea promising an immediate military counterstrike if provoked. North Korea’s army has said it had received approval for a nuclear strike on the United States, adding that the situation on the peninsula had reached an explosive stage. Analysts say a full-scale conflict is extremely unlikely and North Korea's threats are instead aimed at drawing Washington into talks that could result in aid and boosting leader Kim Jong Un's image at home.
Source: Violet Arch Research; Various news-paper articles
- Crude price Arrived at a specific formula approved by the government in the PSC. Discount to brent crude ranges in between 10% to 15%.
Since Aug’09 Royalty It is 20% of well-head value. However, it works out to 15-16% of realizaed value and may vary slightly depending on government calculation of post well-head value. A further 5% increase in royalty could impact FY14 EPS by ~7% and valuation by ~6%.
Last increased in Feb’12
Cess
Cess increased by government in budget FY13 from Rs 2500/MT to Rs 4500/MT. There is a chance of hike in cess going forward. However, too high a hike or too frequent a hike in cess may also impact ONGC and Oil India to a large extent with their crude realization being determined by government. An increase in cess by Rs 2000/MT further could impact FY14 EPS by ~7% and repeatedly similarly thereafter every three years could affect valuation by ~10%.
- Cost Petroleum
Cairn is allowed to recover its capex and production costs (upto 100% of revenues) before sharing any profit petroleum. However, government may disapprove some capex or costs upon its own assessment. Government has earlier rejected USD 238mn of capex by Cairn during its previous exploration phase in Rajasthan block.
Since Q1FY12 Profit Petroleum
Post all the cost recovery, Profit Petroleum sharing with the government as is calculated as per the investment multiple. If government disapproves some costs, the share of profit petroleum of Cairn may decrease. In FY14 government share of profit petroleum will be 30% compared to 20% in FY13 and it will impact FY14 EPS by ~12%.
Since Aug’09 Tax Holiday Seven year tax holiday form the start of production. However Cairn continues to pay Minimum Alternate Tax (MAT). Also, any gas commercialization may not come under tax holiday as natural gas is not considered as mineral oil.
Signed in May’94 Contract period The contract is valid upto May 2020 and can be extended on mutual agreement but terms may be changed by DGH while giving approval for extension.
Government may take decision this year or next.
Gas price hike
As per recommendations of Rangarajan panel, the government may look into hiking the price of gas by linking it to a price arrived upon by taking into consideration gas prices across various sources. Cairn is looking forward to monetize its gas discoveries in Rajasthan block. However, Rajasthan being a pre-NELP block gas price will be determined by government. For any discovery from NELP blocks awarded to Cairn, gas price hike would be a positive step. Recently, Cairn has started commercial sales of its gas produced from Rajasthan block. At present it ~0.14mmscmd and adds about Rs 500mn to revenues. Every $1/mmbtu increase in gas price could increase its revenues by ~100mn.
Government may take decision this year before NELP X auction.
Profit sharing model to revenue sharing model
Under the existing production sharing contract (PSC), the contractor first recovers his expenditure before sharing profit. What is under consideration is production-linked payment, which is said to be more transparent and will have less intervention in routine exploration and development activities. Under this proposal, oil companies would have to pay the Government an agreed amount, depending on the level of output, and not on the investment in the exploration block. The existing production from Rajasthan block comes under profit sharing model. However, with Cairn embarking once again on exploration programme in Rajasthan block, any new commercial discovery may come under revenue sharing model.
Allowed since Feb’13 Allowing exploration in producing blocks
The petroleum ministry has allowed exploration in mining lease (producing fields) areas but exploration costs will be allowed for cost recovery only if a discovery is technically and commercially viable. The contractor will therefore carry out further exploration activities at its risk in the Mining Lease area, after the expiry of the exploration period. Positive for the whole sector. Cairn has already embarked on a 3 year exploration programme in Rajasthan block to tap 3.2bnboe of reserves of exploration upside. However, the costs will be recoverable only on the establishment of commerciality of discovery.
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Defense ministry declaring certain exploration areas as No-Go areas.
Force majeure had been declared in Cairn's KG-OSN-2009/3, MB-DWN-2009/1, PR-OSN-2004/1 blocks due to the denial of permission to carry out exploration activity in the restricted area by the Ministry of Defence. CCI in its meeting held in Mar’13 has given clearance for exploration activity in small portion of the KG-OSN-2009/3 block. However, further clarity is awaited on the rest of the blocks.
Jun’11 to Sept’11 Cairn-Vedanta deal
The government gave its approval for the Cairn-Vedanta deal only after Cairn agreed to make royalty cost recoverable in the Rajasthan block. Prior to this, as per a previous agreement, the entire royalty burden was being borne by ONGC which owns a 30% stake in the block. The government also forced Cairn to withdraw a court case against cess levied in the Rajasthan block which it was paying under protest.
Additionally, CIL estimates about 165mmboe of recoverable resources from Barmer Hill and 19
other fields, besides another 530mmboe, compared to 250mmboe earlier, from the exploration
upside. CIL expects incremental production from these resources, which will help the company
to achieve its long-term target of peak production of 300,000bopd from Rajasthan Block.
MBA field production rates
CIL has the requisite approval for production in Mangala, Bhagyam and Aishwarya for
150,000bopd, 40,000bopd and 10,000bopd, respectively. It has secure approvals for further
scale-up of production from Bhagyam and Aishwarya.
Current production
rate (bopd) Approved production
rate (bopd) Peak production rate
(bopd) Comments
Mangala 150000 150000 150000 All approvals in place
Bhagyam 25000 40000 Not yet disclosed Revised FDP for higher rate yet to be submitted
Aishwarya N.A.* 10000 20000 Revised FDP for 20,000bopd yet to be submitted
Source: Violet Arch Research; *CIL has commenced production in Aishwarya field on 25th
Mar’13. However, the data is not available
Peak rate calculation
Although the management has not given any guidance on the peak potential of Bhagyam Field,
we expect the same to be about 50,000bopd as per calculations shown below.
2P Reserves (mmboe)
Peak production rate as of now as per company (bopd)
2P/Peak rate Peak production
rate as per our estimate (bopd)
2P/Peak rate
Mangala 477 150000 3.18 150000 3.18
Bhagyam 151 40000 3.78 50000 3.02
Aishwarya 66 10000 6.60 20000 3.30
Rageshwari & Saraswati 12
3500 3.43
Total 706 200000 3.53 223500 3.02
Source: Violet Arch Research; This is our own assumption and is not based on any scientific theory. Peak rates could vary depending on reservoir characteristics.
MBA production schedule over FY14-15
Rajasthan Block has the requisite approval for achieving a production rate of 190,000bopd.
However, due to delay in ramp-up of Bhagyam and commencement of production from
Aishwarya, it is unable to clock a production rate currently beyond 175,000bopd. Also the
pipeline capacity (175,000bopd) constraint has to be taken care before ramp-up at Bhagyam
happens. The management has indicated that the pipeline can support 10% additional flow-rate
with debottlenecking. Further, the company plans to use DRA (Drag Reducing Agents) to reduce
the viscosity of oil so that flow rate could be increased further to support the upper-end of
management guidance of 215,000bopd. We estimate an exit rate from MBA of 195,000bopd