Maintain Neutral on CAIRN INDIA - Motilal Oswal

Cairn India (CAIR IN, Mkt Cap US$13.9b, CMP Rs343, Neutral) announced an oil and gas discovery in its on-land JV block, KG-DWN-2003/1 (NELP V). This discovery is in the 5th well drilled in the block under its 5-well drilling plan. Company has notified the discovery to DGH. Cairn is the operator in the block with 49% participating interest, while ONGC holds 51% participating interest.

- 5-well drilling program completed with 1 discovery: Drilling of its 5-well drilling program had commenced in 1QCY10. Of the 5 wells drilled; 1) Nagaram-1, 2) Daliparu-1, 3) Lankepalli-1, 4) Krishna-1 and 5) Nagalyanka-1; some gas was found in the first 3 wells, however were plugged. The announced discovery is in the 5th well which flowed the rate of 75bpd of oil and 0.27mmscfd of gas during DST-2 testing in the 4,055-4,071m interval.

- Significant hydrocarbon pay, but rock formation tight: The well encountered 200m hydrocarbon zone however is of tight sandstone with low porosity and permeability (similar to Barmer Hill in Rajasthan).

- Reserve potential will be known only after appraisal: The company will test the well results for accessing commercial potential of the discovery and to determine the future appraisal programme. Currently, we do not assign any specific value to this block and is included in our exploration potential upside of Rs15/sh for all of Cairn's exploration acreage.

- Key assumptions: We model long term Brent crude price of US$75/bbl in our estimates and take a discount of 12.5% (~US$9/bbl) for quality and add customs duty on crude at 2.5%. We assume that Cairn will be required to pay cess (levy) of Rs927/MT v/s the current cess rate of Rs2,675/MT (including education tax and NCCD cess) for our DCF valuation. Higher cess payment than our estimate would be negative for Cairn by Rs23/share.

- Stock price more dependent on news flow on Vedanta's purchase of stake in Cairn India: Vedanta group has announced its plan to acquire 51-60% stake (US$8.5-9.6b) in Cairn India through purchase of Cairn Energy PLC's stake and through open offer. Sale price has been agreed at Rs405/sh, which includes Rs50/sh as non-compete fees. We believe ONGC's (30% partner in Cairn's key Rajasthan asset) and government's stance on the acquisition will also be important for smooth completion of the transaction. Our SOTP-based Target Price for Cairn was Rs314. At long-term Brent price of US$80/bbl, our SOTP value would increase to Rs330/share. Maintain Neutral.

Cairn's fair value is highly leveraged to oil prices. The chart below gives our estimate of base fair value at different long-term Brent oil prices.

Source : Equity Bulls

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