Cairn India: Why analysts are bullish on the stock

Shares in Cairn India fell 1.7 percent in morning trade after its January-March earnings lagged estimates due to one-time cost in drilling wells at its Sri Lankan asset and South African blocks. Cairn India’s net profit during the quarter rose 17.1 percent on year to Rs 2,564 crore.

The Cairn India stock has lost over 13 percent in 2013 due to the decline at its biggest field Mangala in Rajasthan, t he production from which is expected to trend downwards from current 150,000 bpd.

Mangala, the largest of the 25 oil and gas finds made by Cairn in Block RJ-ON-90/1 in Thar desserts of Rajasthan, began production in end August 2009 and has been producing at the approved peak of 150,000 bpd.

Investors were also concerned about Cairn India meeting its output guidance.

However, HSBC believes the next leg of the rally in Cairn India will come from reserve upgrade and production ramp-up. The Rajasthan oil block is the main driver of Cairn’s stock price.“Our analysis indicates that the in-place oil volume can potentially more than double from current guidance of c7bn boe. This is on account of upside from the top layer called the Barmer formation, which is similar to shale oil,” added the HSBC report.

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Output guidance maintained, some relief

But despite these concerns, the management is confident of closing the current fiscal with a production rate of 200,000-215,000 bpd from the current 175,000 bpd. It was also sure of a plateau production of 1500,000 bpd in Mangala through FY14 with drilling of 48 infill wells for whichOperating Committee’s approval is already in place while the Management Committee’s approval, which is headed by the oil regulator, the Directorate General of Hydrocarbons (DGH), is awaited.

Ramping up output at Bhagyam, second largest Rajasthan discovery

Secondly, the company is scaling up production at Bhagyam, the second largest discovery in Rajasthan, to 40,000 bpd, and Aishwarya, which only recently commenced production, should reach its peak of 10,000 bpd in the coming months as the performance so far has been as per expectations.

“For Bhagyam, there are 66 wells drilled for the current output of 25kbpd and Cairn has room to drill another 30 wells to reach its approved 40kbpd output level by H2FY14 as the individual well productivity has been lower than expected,” said brokerage Elara Capital in a research report.

Increase in Rajasthan capital expenditure to expedite exploration drilling

The company has projected capital expenditure of Rs 13,000 crore over the next three years to increase production. Cairn plans to drill over 450 wells in the Rajasthan block over a period of three years, including 100 exploration and appraisal wells, and 50 percent of the prospective resource volume will be tested in the very first year.“The success of this should alleviate concerns on production ramp-up,” said ICICI Direct in a research note.

The company plans to spend Rs 5,000 crore on its Rajasthan oil fields in three years to 2016 under a new integrated development plan, even as it seeks extension of block contract beyond 2020.The company also wants back all of the area it had contractually relinquished.

It is also developing the prolific Barmer Hill in the basin, which is expected to start production this fiscal. Cairn has submitted an integrated block development plan to the government which seeks to expedite the entire approval process and reduce the time cycle between “discovery and delivery” of output from the basin.

“Over the next one year, possible announcements such as reserve estimates in Sri Lanka block, new discoveries in Rajasthan field, utilization of huge cash on the balance sheet willbe the triggers for the stock. Cairn continues to be one of our top picks in the oil & gas space,” said brokerage IIFL which has a Buy rating on the stock.

“Key operational factors to watch in the medium term would be (a) production rampup and (b) reserve updates, with ongoing 100-well exploration program at Rajasthan. With increasing cash on the balance sheet, clarity on utilization will be a positive,” said Motilal Oswal in a note today.

Higher crude realization going ahead

However, a key concern is the sharp decline in crude oil prices. Crude oil prices are already trending downwards and the outlook in the near term seems bleak.

But for this fiscal, the company for its Rajasthan crude has given guidance of a discount of $8-$13 a barrel on Brent. Hence, Cairn India is set to get a higher price for its crude in FY14, which always trades at a discount to the Brent benchmark, due to favourable pricing terms in new crude sale contracts.