Investors with a long-term perspective can consider accumulating the stock of oil explorer Cairn India. The company stands to gain from likely production increases over the next two to three years, high crude oil prices and a weak rupee. At its current price of Rs 350, the stock discounts its trailing twelve-month earnings by an attractive 7.4 times. Cairn’s current production in its mainstay Rajasthan fields is 1,75,000 barrels of oil per day (bopd). The company is in a position to increase output to around 2,00,000 bopd over the next year. It is also optimistic of achieving its target production of 3,00,000 bopd in the next few years, subject to receiving government approvals.
Approvals, though delayed, should eventually come through, given the company’s improved working relationship with its public sector partner ONGC and the potential savings to the government from lower import of crude oil. Meanwhile, the company is testing the use of new technology (drag reducing agents) to increase its pipeline capacity from 175,000 bopd to 200,000 bopd. This process is expected to be completed by the end of this fiscal. Cairn India is also looking to expand overseas and has obtained controlling interest (60 per cent) in a high-potential gas asset in South Africa. This, along with its gas block in Sri Lanka, should supplement output growth. Crude oil prices, which have been buoyant (Brent is around $112 a barrel), should find support from the new stimulus measures announced by both the US and the Euro Zone authorities. This benefits Cairn India which is a pure-play on the commodity. Cairn’s output is priced at around 15 per cent discount to Brent crude. A weak rupee also benefits the company and improves its realisations.
Cairn India’s June profits grew by around 40 per cent year-on-year thanks to heavy forex gains, higher production and better prices. Excluding the forex component, the company’s profits grew by nearly 9 per cent. With a robust financial position (cash in excess of Rs 7,000 crore as on March 2012) and negligible debt-to-equity, Cairn has enough financial muscle to fund its expansion plans. The company’s proposed new dividend policy (subject to government approvals) of paying out 20 per cent of profits will also benefit shareholders.
Risks to the recommendation include inordinate delays in government approvals, a sharp dip in the price of crude oil, and a steep appreciation in the rupee.