Cairn India: Low on cash; Rating 'Reduce'

Updated: Jul 28 2014, 16:41pm hrs
We see the related-party loan facility of $1.25 bn extended by Cairn India to a subsidiary of Sesa Sterlite as a significant negative, as it warrants concern on effective utilisation of cash/equivalents and future cash flows of the company. We retain our Reduce rating on Cairn India stock with a revised DCF(discounted cash flow)-based target price of R330 (R355 earlier) factoring in risks to cash utilisation through higher cost of equity.

Loan extended for two years: Cairn India has extended $1.25 bn of loan facility at an interest rate of 3% above Libor to a subsidiary of Sesa Sterlite for two years, backed by a corporate guarantee from Vedanta Resources Plc. Cairn has disbursed $800m till date and plans to provide the remaining $450m in the near term. We note that Cairn has taken approvals for extending this facility from the Board and Audit Committee, in which the related parties were not allowed to vote. However, the related-party loan facility is worrying in the light of the large debt levels of Sesa Sterlite. The management indicated that the yield on the loan is better than other investment instruments. It ruled out the option of returning surplus cash to shareholders as dividends, as the company may require the given amount for capex on development of new discoveries from FY17 onwards, by which time the loan will be repaid to the company.

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In-line Ebitda and net income: Cairn India reported Q1FY15 Ebitda and net income (excluding exception item) in line with our estimates at R33.1 bn (-14% q-o-q) and R27.2 bn (-10.4% q-o-q) respectively, as lower-than expected revenues and higher DD&A (depletion, depreciation and amortisation) expenses were offset by lower operating costs and higher other income. Reported net income of R10.9 bn included an exceptional item of R16.3 bn pertaining to impact from retrospective change in accounting of depreciation. Gross production from the Rajasthan block declined 4% quarter-on-quarter to 183.2 kboe/d (thousand barrel of oil equivalent per day.) Crude price realisation for the Rajasthan block rose 2.7% q-o-q to $97.5/bbl, at 11% discount to Dated Brent.

Fine-tune estimates: We revise our FY15-17e EPS (earnings per share) to R55.3 (+1.3%), R48.2 (-3.1%) and R36.4 (-7.4%) to reflect (i) Q1FY15 results, (ii) higher DD&A charges and (iii) other minor changes.

Q1 results

n Sequential decline in production from Rajasthan block. Gross production (oil and gas) from Rajasthan block declined to 183.2 kb/d in Q1FY15 from 190.9 kb/d in Q4FY14. The production from Development Area 1 comprising Mangala, Aishwariya, Saraswati and Raageshwari fields declined to 153.5 kb/d in Q1FY15 from 162.2 kb/d in Q4FY14. The production from Development Area 2 comprising Bhagyam field increased to 29.7 kb/d in Q1FY15 from 28.6 kb/d in Q4FY14.

n Lower oil and gas production from Ravva. At Ravva, oil production declined by 10.6% y-o-y and gas production declined by 31.6% y-o-y. At CB-OS-2, oil production declined by 1.8% y-o-y while gas production increased by 7.7% y-o-y.

n Higher crude price realisations. Crude price realisation increased to $98.2/bbl for the company versus $94.6/bbl in Q1FY14 and $95.7/bbl in Q4FY14. Crude price realisation for Rajasthan block was at $97.5/bbl (~11% discount to Dated Brent crude price) versus $94.3/bbl in Q1FY14 (8.4% discount to Dated Brent).Gas price realisation declined sequentially to $5.6/mcf (million cubic feet) versus $4.9/mcf in Q1FY14 and $6.1/mcf in Q4FY14.

n Steady other income. Cairns core other income rose modestly to R4.2 bn in Q1FY15 from R4.1 bn in the previous quarter. Cairn has reported forex fluctuation gain of R1 bn in Q1FY15 versus loss of R2.4 bn in Q4FY14.

n Higher DD&A expense. Cairn reported higher DD&A expense at R7.2 bn (+13.1% q-o-q and +38.6% y-o-y) led by change in method of depreciation for some of its oil and gas assets from Straight Line method to the Unit of Production method, in compliance with the Schedule II of the Companies Act, 2013. The company has also accounted an exceptional item of R16.3 bn (net of tax) from implementation of change in depreciation accounting on a retrospective basis, as prescribed in Accounting Standard 6. The company reported higher exploration cost of R2.5 bn versus R1.6 bn in Q4FY14.

n Low effective tax rate. The effective tax rate for the company remained low at 4.5% in Q1FY15 versus 5.1% in Q4FY14 and 1.9% in Q1FY14 due to MAT credit

of R5.6 bn.

Other updates

n Exploration in Rajasthan block. The company has established 1.2 bn boe of in-place hydrocarbons from its ongoing exploration campaign in the Rajasthan block and discovered an additional 0.6 bn boe, which is in various stages of testing. The company expects to establish an additional 1.2 bn boe of in-place hydrocarbons in FY2015-16, targeting to take the total discovered in-place hydrocarbons to 7 bn boe.

n MBA EOR project. The management indicated that Cairn is on track to commence polymer injection in Mangala field by 4QFY15. The company has started construction of surface facilities and drilling of EOR (enhanced oil recovery) wells using two rigs.

n Barmer Hill and satellite fields. Production has commenced from Mangala and Aishwariya BH fields in 1QFY15, and initial results are in line with expectations. Cairn has also started production from its satellite fields, with contribution from Raag S-1 beginning in Q1FY15. Production from NI and Guda satellite fields to begin in Q2FY15.

n Conclusion of buyback programme. Cairn India has bought back 36.7 m shares in its buyback programme for a total amount of R12.3 bn, which is 21.4% of the proposed maximum consideration of R57.3 billion.

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