Cairn India produced 217,869 barrels of oil equivalent per day in the first quarter of fiscal 2015, in line with our estimates and company’s guidance for flat output in 2015. Revenue and net income both were in line with our estimates. Similarly, the operating margin decline was in line with our 5-year forecast as the main field is maturing and the sweetest part was produced first. Depreciation increased due to a change in accounting rules, but this has no material impact on our fair value estimate, which is based on discounted cash flows.
Cairn will lend about $1.25 billion to its parent for two years at a yield of Libor + 3%, which, if compared with domestic yield, could possibly lower the non-core Treasury income. Libor +3% is a reasonable rate but it would be advisable for the company to give more clarity on the discovery of pricing on the transaction.
With a fair value estimate of Rs 400 per share, Cairn India is undervalued.
Cairn India's narrow economic moat is underpinned by the onshore Rajasthan block, which is the dominant revenue source and has a very low operating costs of about $4/bbl. High fair value uncertainty reflects exposure to crude which is a globally traded commodity and Cairn India’s untested ability to successfully explore and execute deep water oil and gas exploration and production projects. Low-cost production, coupled with a relatively attractive production sharing contract with the Indian government, helped Cairn to report one of Asia’s highest net profit per barrel ($65) in 2014.
An upcoming catalyst for the stock this year is the likely extension of the production sharing contract for the Barmer oil block, which is set to expire in 2020.
We maintain our 5-year forecast of 9% compounded production volume growth and our forecast for cumulative free cash flow of $6.2 billion.
