The Case For Cairn

The Company:

Cairn Energy, based in Scotland is an independent and frontier exploration company. They typically go into countries and regions that regions that Big Oil has overlooked. They are a pure play in terms of oil and gas exploration as they are not into owning or running gas stations or refineries.

Cairn Energy has two distinct subsidiaries:

A. Cairn India and

B. Capricorn Energy

The Assets:

1. Near Term Trigger

The most significant asset that Cairn India has is the oilfields in Rajasthan India. The oilfields of Mangala, Aishwariya, Saraswati and Raageshwari in Rajasthan have an estimated 3.7 billion barrels of oil. Cairn owns 70% of these oil fields (ONGC, one of the Indian national petroleum companies owns the other 30% and not all the oil is extractable).

Cairn expects to start production at 30,000 barrels a day in the second half of this year and ramping it up to a peak production of 125,000 barrels a day by 2011. The 125,000 barrels per day is expected from the MBA fields (Mangala, Bhagyam and Aishwarya). These figures do not take into account any other oil finds that Cairn may find and exploit elsewhere in India.

2. Exploring outside of Rajasthan

A. Sri Lanka – In the Sri Lankan waters close the Krishna Godavari basin (where India has discovered its biggest gas find ever), Cairn has rights to explore hydrocarbons in a 1,500 square km. Cairn India owns 100% of this field.

B. North India – The Ganga Valley sedimentary basin is one of the most under explored basins in India. Cairn India owns 50% of the rights to explore acreage in Uttar Pradesh and Bihar.

C. Eastern India – Cairn’s focus in the East is based on the Ravaa oilfield in the KG basin (Krishna Godavri basin). In partnership with 2 other companies, Cairn India is producing 50,000 barrels a day from this field and can process 70,000 barrels per day, 95 mmscfd of natural gas and 110,000 barrels per day of injection water.

D. Western India – In partnership with 2 other firms, Cairn has been producing gas from the Lakshmi gas fields in the Cambay basin.

E. Greenland – Cairn is exploring 3 different basins in Greenland that are suited to oil and gas deposits with a total of 72,000 sq km under license for exploration.

F. Mediterranean – Cairn is also bidding and exploring for oil in Tunisia, Spain & Albania.

G. Capricorn – All of the non Indian assets that Cairn Energy holds are owned via a subsidiary called Capricon Energy. Capricorn Energy Limited (“Capricorn”), a subsidiary of Cairn is the exploration focused arm. Capricorn now has assets in Bangladesh, Nepal, Northern India, Greenland, Tunisia, Peru, UK (West of Shetlands), Albania, Australia, and pending licence awards in Spain and Sicily.
Cairn Energy holds 90% of Capricorn, an unlisted subsidiary.

Risks:

1. Oil prices fall and stay there for a while

My perspective is that even if this happens, usage of petroleum in India will continue to remain strong. At the end of the day, we are talking about a commodity that is depleting and that we will eventually run out of. Sooner or later prices will go back up and stay there.

2. Taxation

The state of Rajasthan goes back on its word and decides to tax Cairn heavily for the oil it draws out of the ground. The Chief Minister has already hinted at raising taxes on Cairn and others.

Again, if this does happen, Cairn has shown in the past that is not afraid of going to court and fighting for its rights. The federal government in India understands that after many years, the oil majors are slowly looking to India for exploration. With a Congress government both in Rajasthan and the Centre (federal level), I think it is unlikely that the Rajasthan government will tax Cairn to death.

3. Low quality Oil

When the GOI (Government of India) forced the state owned oil companies to firm up buying of the waxy crude that is produced by Cairn India, there was confusion about pricing the crude given its high viscosity.
However, those concerns have been laid to rest and Cairn has now signed deals that ensure that the crude will be sold and they have ready customers - http://www.thehindubusinessline.com/2009/07/20/stories/2009072051570100.htm

4. No additional oil is found

Usually where some oil is found, there are chances of finding some more oil. But investors should consider the possibility that despite promising seismic surveys and geology, Cairn may not find any major discoveries in its other explorations.

Valuation:

Here is how I have valued the MBA fields, Cairn India’s most promising asset.

Please click on the graphic at the top of this post to expand and view the excel table. I have yet to figure out how to paste tables from Word or Excel into blogger.


At $ 40 a barrel, Cairn India has an enterprise value of $ 10.5 billion.

A. Reserves have been taken at a conservative 500 million recoverable barrels versus the company aiming for 685 million - http://www.livemint.com/2008/03/31142600/Cairn-India-raises-projection.html

B. Average net margins have been taken at a conservative 15% compared to the 40% plus in the valuation done by IndiaBulls - http://www.business-standard.com/pdf/tu953%20cairn%20india%20090701.pdf

C. Assumed a conservative PE ratio of 5 for Cairn. Comparatives can be viewed at http://biz.yahoo.com/ic/123.html (9.1 PE for Independent Oil & Gas producers)

D. Current price on July 21, 2009 is Rs 245 or - http://www.business-standard.com/stockpage/stock_details.php?bs_code=11204 and http://in.finance.yahoo.com/currency/convert?from=USD&to=INR&amt=1&t=1y
How to best play Cairn India?
Cairn Energy, the parent company trades in the UK markets and owns 69.5% of Cairn India. To follow stock movements of Cairn Energy, used this http://uk.finance.yahoo.com/q?s=CNE.L

Recommendation:

At a conservative $ 40 a barrel, Cairn India has an enterprise value of $ 10.5 billion. The market cap of the company on the Indian markets is at USD 9.3 billion and too far off from the $ 10.5 billion I have calculated/estimated.

Cairn Energy stock on the UK markets has a market cap of 3.32 billion sterling. At an exchange rate of 1 sterling being 1.64 USD, that translates into a market cap of USD 5.45 billion. Theoretically speaking the 69% of Cairn India should translate into USD 7.3 billion.

In light of the above, I would propose that at current prices Cairn Energy stock represents an opportunity to buy into the MBA fields at a discount and get exposure to all of the other exploration that Cairn Energy has lined up at zero cost.
If you wish to buy Cairn and wait till 2011/2012 (my suggested hold period), I would suggest buying it on the UK markets.

Investment Theme 1

Source: http://www.climate-policy-map.econsense.de/factsheets_download/factsheet-energy-efficiency.pdf

If a picture is worth a thousand words, then the graph above should clearly shows huge $$ signs. All the 3 major BRIC nations are at the bottom of the heap in terms of per capita consumption of "Primary Energy".

Imagine a life without gasoline, electricity and all that these vital inputs provide and help produce.

In terms of power plants, transmission grids, electrical transformers etc, clearly there remains a massive amount of money and investment that will be required. But in the case of India, I believe that primary hydrocarbon exploration represents a major multi-billion opportunity.

Allow me to list my reasons:

1. Under Explored Terrain - India is an under-explored country (seismically speaking). It is only recently that overseas companies have been allowed to explore for oil and gas. Google the phrase "NELP exploration policy" and see what you find. India's hydrocarbon czars have some what awakended from their slumber and are reacting to what is a strategic shortage and choke point.

2. Geology - Geologically the prospect seem good with oil discoveries having been made in Rajasthan in recent years and massive gas deposits having been found off the Eastern coast in India.

A map of all the major basins can be viewed at http://www.iypeinsa.org/updates-09/art-45.pdf (looks like a 2004 document)

3. Captive Market – India imports something like 75% of its crude requirement. With the rising middle class and the ambition/dream of every family owning an automobile or two, India is a long way away from suffering from a glut of crude oil and gas.

Source: http://timesofindia.indiatimes.com/Business/India-Business/Inflation-to-average-5-in-FY10-Assocham/articleshow/4725571.cms

With most purchases of electricity being done by bankrupt State Electricity Boards, for now, I believe the singular theme as far as a energy is concerned should be E&P (Exploration & Production) plays with an India focus.

Investing Philosophy

I am a regular guy just like who. Perhaps like you I have lost 40% of what I invested in the market meltdown of 2008 and 2009.

But I have also made significant profits on stocks that I bought and held as a 20 something old in India. I am thankful to my father for teaching the values of frugality and clear thinking on what to buy and why.

After the recent carnage, surely every one realizes that investing for the long terms, the next 5 to 10 year horizon, can only be done by investing in the developing countries. Any one read or heard about the concept of Marketing to Bottom of the Pyramid. Those familiar with the web economy, think of micro-payments applied at a massive scale. That is what the developing nations represent.

When it comes to developing nations, India is probably the country that I know best having lived and grown up there and having a connection to that society.

Since I live outside of India, I will try and list stocks that overseas residents can buy.

I will not be suggesting prices you buy stocks at but will list stocks that I believe will strongly rise over the long term (5+ years).

I have deliberately titled the blog "Investing With India" as I believe that is the best way to make money. As India invests in her own future, being a participant in that process will yield, good, solid and yes, stable returns.

Happy reading

Harmit Singh Kamboe