Why you should bet your bucks on Cairn India

While Morgan Stanley has downgraded its views on the entire oil and gas sector to ‘cautious’ due to fearof falling refining margins and higher subsidy burden - even downgrading Reliance Industries to ‘underweight’ along with other oil marketing companies (OMCs) like HPCL and BPCL - Cairn India has emerged as its only star.

Morgan Stanley believes that Cairn India will stand out in the crowd, due to its high growth of 18 percent in production over financial year 2011-15 - mainly driven by their Rajasthan field. Along with higher production, stable oil prices should help Cairn generate free cash flows.The concern of using the cash should also be resolved in the first half of this year.

The government has said it will either announce a policy to properly deploy the cash or give it back to investors in the form of dividends. Its valuations are at around 29 percent discount compared to global peers making it look very attractive.

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[caption id=“attachment_181145” align=“alignleft” width=“380” caption=“Morgan Stanley believes that Cairn India will stand out in the crowd, due to its high growth of 18 percent in production over financial year 2011-15.”]  [/caption]

Analysts say refining margins are now set for a structural decline and matters could get worse before improving. So both Reliance Industries and Essar Oil have been downgraded as a result of the negative outlook for refining and lack of triggers for an upside.

The report predicts the oil subsidy burden for India could be Rs 1.24 lakh crore and could touch even Rs 1.32 lakh crore if the rupee weakens further.

Crisil Research had already put out an estimate of Rs 1.4 lakh crore as oil subsidy for the year. For the financial year 2013, the subsidy burden has been estimated at $26 bn (Rs 1.35 lakh crore).

With 5 state elections round the corner and the Central government election set for early 2014, decontrol of petroleum products and meaningful rise on petrol prices will be difficult to come by. This high subsidy burden and uncertainty over the subsidy sharing arrangement remain key concerns for the public sector oil companies. As a result, Morgan Stanley has also downgraded BPCL and HPCL - this downgrade coming despite a 27 percent correction in the stock prices in recent times.

Analysts have warned that matters will not improve even with regard to payment of subsidy on the part of the government as its own balance sheet is already stretched. And without clarity on reforms stock re-ratings are not possible. For the re-rating to happen, crude oil prices must come down meaningfully as well as reforms by the Indian government in the sector is essential.

The report has also downgraded Gail, due to no significant growth in its transimission volumes. The only company that maintains its rating, along with Cairn, is Oil India. It is the cheapest oil stock globally and its valuations are also historically at an all time low.

With media reports suggesting that the government might ask these companies to raise their dividends, it could bear fruit for minority shareholders. But the negative for the company is its huge cash reserve. If the government asks the company to buy back government shares to fund its divestment program, it will be a negative for Oil India’s valuations.

See Morgan Stanley’s ratings chart below:

[caption id=“attachment_181156” align=“alignleft” width=“419” caption=“Credit: Morgan Stanley”]  [/caption]