A decent bet

A price range of Rs330 to Rs355 has a special significance for Cairn India. It is at Rs355 that an open offer was announced. At `331 per share, Sesa Goa, the holding company of Cairn India, acquired 200 million equity shares from Petronas. A lot of shares have changed hands at these levels. Thus, the range is always tracked closely and can decide the trend in the stock. Cairn India has corrected after touching a high of `401 and presently trades around `354.

The stock has corrected sharply after the Budget raised the cess to `4,500 per tonne of oil produced from `2,500 per tonne. This accounts for around $12.6 per barrel of cess as compared to around $7 per barrel earlier. The impact on the bottomline will be lower as the expense is allowed for tax deduction.
However,  tailwinds — rising oil prices, a falling rupee and a rise in production — will  favour the company.  

As the world grapples slow growth and recession, oil prices are flirting with the $100-per-barrel mark,  unlike in the past. Analysts think this is a supply side problem. Thus, whenever world’s economies improve, demand for oil will increase and this can push prices higher. If the Iran-US tensions escalate, oil prices could hover around $150-200 per barrel. In any case, substantial cooling of oil prices from the current levels is ruled out. While calculating future cash flows, analysts have taken $90-100 per barrel as the base rate of crude oil.

Though Cairn sells its oil in India, its prices are dollar-denominated and are pegged to the comparable lower sulphur content, Bonny Light variety of crude. This type of crude trades generally at a discount of 10-15% to the Brent crude. During the December quarter, the discount over Brent was only 8.3% as demand for lighter crude decreased.

The rupee, after touching a low of 54.30 to the US dollar in mid-December, bounced back strongly on a variety of RBI measures to 48.60 in early February.  Since then, however, it has weakened to 51.00 . In their calculations, analysts have taken a rate of 46.00 to 48.00, while 50.00 is the best-case number of most of the broking firms for the current year.
What prevents growth of Cairn India is infrastructural bottlenecks for evacuating oil. Also, the government cleared increase in its production from January 2012.

Cairn can now raise its production from 125,000 barrels per day to 175,000 barrels per day. Cairn says it has reserves and capacity to raise production to 240,000 barrels per day, for which it has already sought permission.

Some analysts have pegged the company’s capability of touching 3 lakh barrels per day by 2013. The company already has a sales arrangement in place to supply 1.70 lakh barrels per day to various public sector and private refiners.

The other constraint to growth is the pipeline required to evacuate oil. Laying pipelines through the desert and getting farmers’ permission to access their land is proving to be a tough task.
Though the rated capacity of the current pipeline is 1.75 lakh barrels per day, the company says it can handle much higher capacities with some additional equipment. Cairn is in the process of adding 80 km of pipeline which will then make the crude oil available at the ports.

Annualising their December numbers, earning per share (EPS) for Cairn works out to `47.40, discounting the current share price of `350 by only 7.3 times. With volume slated to double over the next two years and crude oil holding above $100 per barrel despite the global economic slowdown, Cairn offers a decent long-term bet, especially since it trades at a very important range where the current promoters have raised most of their stakes.

Stockwatch