Stock Review: CAIRN ENERGY

The unexpected and sudden waiver of non-compete fee by Cairn Energy seems to confirm the fears of retail shareholders that Cairn India's valuations have more risks than what various brokerages would make them believe. The scrip, which had peaked ahead of the Sesa Goa's open offer during April – May 2011, is now trading nearly 15% lower. With crude oil prices on a downward journey, the scrip could lose further value in coming days.
This is surprising when Cairn India had only recently upgraded the production potential of Rajasthan field to 300,000 barrels per day (bpd) from earlier 240,000 bpd. Similarly, its estimate of recoverable reserves was raised to 1.65 billion barrels from formally approved 0.7 barrels. The current approved production level is 175,000 bpd, out of which the company has achieved 125,000 bpd.

The voluntary waiver of noncompete fee — or a 12.3% reduction in Cairn's earlier price — is being termed as the company's acceptance to share the royalty burden with ONGC. Although no official announcement is made yet, if true, this will have a negative impact on Cairn's value. According to Goldman Sachs the royalty burden would reduce . 62 — more than 15% — per share from its current target of . 405 for Cairn India.
"In case Cairn India has to bear its pro-rata share of royalty, we expect its FY12 and FY13 royalty burden to increase to . 2,430 crore and . 2,940 crore. It will also have to provide for . 1,350 crore towards its share of past royalty. Our base case NAV would decline to . 250 per share from . 305," mentioned Sandeep Randery of BRICS Securities, assuming $75/ barrel oil price.

Needless to mention, this will benefit ONGC, which holds 30% in the fields, but pays entire 100% royalty at present. BRICS estimates additional net profit of around . 1,600 crore for ONGC in FY12, if the royalty is shared by Cairn. Even after a reduced share price, ONGC appears unlikely to announce a counter offer simply because Cairn Energy and Vedanta Group, between themselves, control more than 80% of Cairn India's shares. In such a scenario a counter offer is bound to fail.

Cairn India is currently producing from Mangala field while the Bhagyam and Aishwarya fields are under development. 40,000 barrels per day production from Bhagyam is expected to start in second half of 2011, while the Aishwarya is scheduled to commence operations from mid-2012 onwards.