The Cairn India stock was marked down nearly 7 per cent in today’s trade. This is more a reflection of the market’s disappointment over the surprise revelation of a big-ticket loan given by the company to a related party, and less about Cairn’s weak show in the June quarter.

Cairn, in the June quarter, entered into an arrangement to lend $1.25 billion to a subsidiary of Sesa Sterlite – also a part of the Vedanta Group. Of this, $800 million has already been lent by Cairn for two years and the balance $450 million will be given in the coming quarters. The company’s stand that the interest rate on the loan – LIBOR plus 3 percentage points – will give the funds a better return than the 2 – 2.5 per cent they earn currently did not quite wash with the market.

One, lending the funds is a departure from the company’s earlier position that it will retain its formidable cash reserves for significant capital expenditures (about $3 billion) planned over the next few years to increase output from its mainstay Rajasthan asset. As of March 2014, Cairn had Rs 13,707 crore in rupee funds and $1.53 billion in dollar funds. The $1.25-billion loan facility is more than 80 per cent of the company’s dollar funds of March. Two, since Vedanta’s takeover of Cairn India in 2010-11, a section of the market has been worried that Cairn’s cash may be used to bail out weaker companies in the Vedanta Group. The loan facility to a subsidiary of Sesa Sterlite, which has not been in the best of health, seems to vindicate these concerns.

Sure, there’s a corporate guarantee given by Vedanta Resources Plc for this loan, but this is in the nature of a parent level guarantee and is not asset-backed. Also, it did not help that this major related-party loan transaction came as a surprise during Cairn’s June results conference call and was not disclosed by the company as and when it happened. The name of Sesa Sterlite’s subsidiary which gets the loan and the end use of these funds has also not been disclosed yet. Finally, if the $1.25 billion was surplus cash with Cairn, it would have earned higher returns if converted and deployed into rupee deposits. The 1-year LIBOR for dollar denominated loans is currently around 0.5 per cent per annum; so Cairn India will get a return of about 3.5 per cent on its loan to Sesa Sterlite’s subsidiary. Rupee deposits with Indian banks would have yielded the company a much better 9-10 per cent. Better still, the company could have returned the cash to shareholders through healthy dividends and buybacks. Last year, Cairn gave a dividend payout of about 22.5 per cent of its profits; this could have been raised. Also, in the share buyback programme which closed on Tuesday, Cairn acquired only 21.4 per cent of its planned purchase; after the sharp fall today, the stock, at Rs 323, trades lower than the maximum buyback price of Rs 335.

The management’s optimism about a big increase in Cairn’s oil and gas resource base in Rajasthan, and its roadmap to increase production sharply in the coming years did little to assuage market sentiment. Of course, it also did not help that the company’s June quarter performance was nothing to write home about, with profit down 65 per cent from the year-ago period. Even excluding the impact of the change in depreciation calculation which accounted for much of the profit decline, Cairn’s June quarter profit is down 13 per cent from the same period last year. Higher costs, including tax and Government outgo, along with lower foreign exchange gains more than offset the increase in overall output and better price realisation. Also, output at the Rajasthan block was 4 per cent lower compared with the preceding March quarter due to an unplanned outage.

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