Cairn India: an oil story worth betting on – a guest post

Nishit’s previous guest post about Bharti Airtel received good reader response that motivated him to write about the stock-of-the-moment in the oil and gas sector. Here are Nishit’s views.

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Oil is also known as Black Gold. The lust for oil has led to many wars. Empires have been built on oil and lost due to oil. Oil prices in the next decade may very easily rule above 100 dollars a barrel. Do not believe it?

As recently as 2002, oil was in a band of 15-30 dollars. Now we are in the 60-80 dollars band. Triggers for oil prices going north are:

• War
• Demand and Supply mismatch. Look at the Hubbert curve which states that post 2020, the oil production will start falling. Demand keeps rising about 2 % every year.

Over the last few years, hardly any new oil fields have been discovered. Also, alternative fuels like wind, solar energy have not really taken off to make a dent in the demand for oil.

Our aim as investors is to make money in Indian companies. In India, we have very few pure oil plays. ONGC and Oil India are crippled by the government’s subsidy policies. RIL has other businesses and is not a pure oil play.

Cairn India is a standalone player in oil production. It has operations in Rajasthan, Cambay offshore basin on the west coast and Ravva on the Krishna-Godavari basin on the east coast. It has stakes ranging from 20% to 70% in these fields and is also the operator for these fields.

Cairn India produces what is known as the Barmer crude which trades at a discount of 10-12% to the Brent crude. There are different types of crude based on the ‘sweetness’ of the crude. By ‘sweetness’, we mean how much of it can be refined and the sulphur content.

For FY 2010, Cairn India produced around 69000 barrels per day. Peak production is expected at 250,000 barrels per day from 2012 - 2015.

The current market valuations are done by factoring in crude prices at around 80 dollars a barrel. Cairn India has ready buyers for its crude from clients like IOC, HPCL and MRPL. The current fair value of Cairn India comes to around Rs 250 - 265 per share taking into consideration all the oil fields it has, the current price of crude oil.

The transportation from the oil fields would be done by trains which are already in place. So the company has oil reserves, transportation facilities and buyers. Thus, crude prices are the only key factors to watch.

One should buy Cairn India if:

• one believes crude oil prices will shoot up to 100 dollars plus a barrel
• one has faith in Cairn’s oil exploration expertise; Cairn is a renowned oil exploration company which uses EOR technology over water flood technology which would extract 45% more oil

I believe the EPS would go to about Rs 40 for FY12 and factoring a P/E of 10-12 would give a target price of around Rs 500.

[Just as I finished writing the post, I heard that the Vedanta group and Sesa Goa may jointly take a 51% - 60% stake in Cairn India. Sesa Goa’s earlier acquisition by the Vedanta group has done no great harm to the former’s share price, so Cairn India’s stock should not be negatively impacted by the takeover news. Sesa Goa’s stock rallied from a low of Rs 68 after the meltdown to a high of Rs 470 about 2 months back.

One should never buy on news based events as all is factored in the price. The prudent course would be to wait for the Cairn India stock to come back to Rs 275 - Rs 300 levels for an entry.]

(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)