Stock Chart Pattern – Cairn India

Nishit had written a guest post about Cairn India where he highlighted the macro-fundamentals, and recommended a price band of 275-300 for an entry. I thought of checking out the stock chart pattern and found that Nishit’s ‘buy’ zone appears spot-on.

But a look at the micro-fundamentals raises the question whether small investors should consider the stock as a part of their portfolio or not. It seems to be a high-risk choice with possible high returns in the future.

Cairn India raised more than Rs 8000/- Crores through an IPO four years ago. The response wasn’t all that great and the IPO price was fixed at Rs 160/- (Rs 10 face-value). Much more than that money has been sunk already in drilling for oil and gas.

The ‘burn rate’ is coming down as the company has started to locate oil and gas reserves at both on-shore and off-shore locations, but Cairn is far away from turning promise into profits. Till date, the company is a loss-making one with almost zero earnings. Now interest costs are beginning to affect the bottom line even further.

The nature of the oil and gas business is that you need to pour a lot of money into surveying and drilling without any guarantees of finding anything at all – in which case, the entire investment has to be written off. It is to Cairn’s and to an extent, the Indian government’s credit that the areas allocated for drilling actually contained sufficient reserves of oil and gas for the venture to be a viable one.

So, why is the promoter – Cairn Energy PLC, which owns more than 60% of the equity capital – planning to off-load its stake to the Vedanta Group? Are they satisfied that their initial investment has more than doubled in less than 4 years? Or, could it be that they don’t want to go through the hassles of setting up a huge administrative infrastructure? May be, they are fed-up with the layers of bureaucracy and corruption at each layer?

Whatever be the reason, the one year bar chart pattern of Cairn India seems to be in a corrective mood:

The stock price reached a peak of 342 in May ‘08 – bang in the middle of a raging bear market. It then dropped 74% to 88 in Oct ‘08, underperforming the Sensex, but bounced up immediately, and handsomely outperformed the Sensex by making a series of higher tops and bottoms.

The stock hit a new high of 368 on Aug 16 ‘10. But the day’s trade formed a ‘reversal day’ pattern on very high volumes. Coming at the culmination of a long bull rally, such a pattern could lead to a change of trend.

A test of the new high (on Aug 24 ‘10) on decent volumes failed, opening up possibilities of a ‘double top’ bearish pattern with a downward target of 300 – which is just below the 200 day EMA. The stock got some support at the 50 day EMA, bounced up above the 20 day EMA, and is heading down again. Today’s close of 329.55 is exactly on the 50 day EMA.

The technical indicators have turned bearish. The slow stochastic and the RSI are both below their 50% levels and slipping further. The MACD is positive, but below the signal line and falling fast. There is support in the 310-320 band, which is the next downside target. Thereafter, the stock may drop to the 200 day EMA, or even below it.

Should investors use the opportunity to buy? That will depend a lot on how confident one is about the Vedanta acquisition going through without a hitch. The recent bauxite mining fiasco in Orissa may queer the pitch. Not to forget that the Vedanta Group has zero experience in the highly complex oil and gas industry.

Bottomline? The stock chart pattern of Cairn India is undergoing a correction after a two years long bull market. Nothing unusual so far. Prudence suggests that the acquisition deal should play out before one enters the stock. Existing holders from lower levels can book part-profits.