Cairn India - Valuation attractive; EPS accretive buyback ideal option - Edelweiss

Our neutral stance on Cairn India (Cairn) since July 2009 has been vindicated—the stock has underperformed Nifty 11.54% (2.7% CAGR) and also Brent 56%. However, we view the recent correction, primarily due to production issues at Mangala/Bhagyam and concerns on cash hoard, as an opportunity to enter the stock. Valuations are supportive—Cairn trades at 2.6x FY15E EV/EBITDAX on FY15E production estimate of 200kbpd, lower than the company's March 2014 exit guidance of 200-215kbpd. Also, we note that current price factors in nil exploration upside. Ergo, we upgrade to 'BUY' with a target price of INR357. We also believe the time is opportune for a share buyback as it will be tax efficient and value accretive for shareholders—10% buyback will boost FY15E EPS 7.7%.

Miss on production guidance, cash pile trigger underperformance

Cairn's underperformance was predominantly due to delays in production ramp up, production-related issues in Bhagyam field, and possible blip in Mangala production. Also, concerns on usage of the large and rising cash pile have led to valuation discount, despite a 20% dividend payout. We lower our production estimate from 200/210kbpd to 181/200kbpd in FY14E/FY15E, with Mangala recovering to 150kbpd in FY15E post EOR and Bhagyam recovering to 40kbpd in FY15E.

Capex guidance aggressive; buyback a value accretive option

Even after assuming higher capex for exploration and development, we perceive Cairn's net capex guidance of USD2bn for FY13-14 to be on the higher side. Hence, we estimate cash to catapult from USD1.8bn at end FY12 to USD3.9bn by FY15. In view of investors' various conjectures on cash usage, ranging from possible merger with Vedanta companies to investment in low return refinery to buying out government's stake in Hindustan Zinc, we suggest buyback as a value accretive alternative - a 10% buyback will boost FY15E EPS by 7.7% and also raise promoter holding by 6.5%.

Outlook and valuations: Attractive; upgrade to 'BUY'

On back of lower production estimate, we cut our target from INR375 to INR357, assuming Brent to average USD105/bbl in FY14/15. Cairn's current price factors almost no exploration upsides (our estimate of INR77/share). Its FY14E/15E P/E of 4.7x/4.9x is also attractive. Hence, we upgrade to 'BUY/Sector Outperformer' from 'HOLD/Sector Performer'. Cairn's SOTP increases by 0.7% for every 1% INR depreciation.

Source : Equity Bulls

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