Investors with a long-term perspective can consider buying the shares of oil exploration and production major Cairn India. Attractive valuations and good prospects for stepping up production support the recommendation. The stock of Cairn India has taken a beating in recent weeks, following the dip in the price of crude oil. Global economic nervousness has led to a fall in Brent crude price from nearly $120 a barrel at the end of April to around $100 now. Cairn India's output is priced at about 15 per cent discount to Brent. While the decline in the dollar price of its output negatively impacts Cairn, it is hedged to a good extent by the near 12 per cent strengthening of the dollar against the rupee since February. This should cushion the company's financials.

At its current price of Rs 324, the stock trades at around 7.8 times its trailing twelve-month earnings. This is a tad lower than the valuation commanded by oil sector peers, ONGC and Oil India. But considering Cairn India's potential to increase production significantly in the coming years, a premium valuation to peers may be in order.

Cairn India, after its acquisition by Vedanta last calendar, has increased output at its flagship Rajasthan wells from 125,000 barrels of oil per day (bopd) to 175,000 bopd. Production has also commenced at the Bhagyam fields. The company has increased its reserve estimates in the Rajasthan asset from 6.5 billion barrels of oil equivalent (boe) to 7.3 billion boe. This should enable increasing oil output to 300,000 bopd, higher than the earlier estimate of 240,000 bopd. The company's profits in the latest quarter dipped 11 per cent due to higher forex losses, combined with outgo towards royalty and cess as per the agreement with ONGC. Yet, its financials are robust with cash reserves in excess of its debt, and net profit margins of around 60 per cent. Cairn India's new dividend policy of paying out around 20 per cent of consolidated profits may see shareholders benefit from regular dividends too.

(This article was published on June 9, 2012)
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