Cairn India

Morgan Stanley research is bullish on Cairn India and has maintained overweight rating on stock with target price of Rs 191.

Morgan Stanley research report on Cairn India

Conclusion:

We are increasing long-term earnings by 20% and upgrading Cairn India to Overweight and raising our price target to Rs191. Our global team has raised normalized long-term crude oil (WTI) price forecasts to USD65/billion from USD55/billion. Cairn is India’s most levered company to crude oil prices. At a 2008E EV/boe of 14.1x, Cairn trades in line with its global peers, though its major production is two years away.

However, on C2010 earnings it trades at 6x P/E compared to an average of 12-13x for its global peers, yielding attractive valuations. Cairn has underperformed the market by 20% since its listing, making entry look attractive at current levels. Mid-Cycle oil prices revised to USD65/billion – Our global team has raised normalized long-term crude oil (WTI) price forecasts to USD65/billion from USD55/billion, prompting us to also raise our 2007/08 assumptions from USD60/billion to USD65/billion.

We also factor in a weaker dollar and higher costs. We are also incorporating a weaker dollar and higher costs into our new estimates to reflect further tightening in the service industry. Every USD per billion change in crude oil prices changes Cairn’s earnings estimates by 3%.

Key risks:

As the Rajasthan crude is viscous in nature, handling is more difficult than for other crudes. Also, as it operates in an inland basin, the company has to create logistics handling systems to get the oil to its consumers. Finally, the amount of cess Cairn has to pay is unclear.

Investment Thesis

Cairn has an excellent track record, with three of the country’s seven landmark discoveries since 2000. It has made 30 hydro-carbon discoveries in India.

Overall, the company has working interests of 498 million boe of proved and probable oil reserves, and has the potential for 740 mmboe via enhanced oil recovery and resource optimization.

Valuation

Our valuation methodology primarily assesses cash flow of individual fields owned by Cairn India based on its 2P reserves. For our base case, we used a 10.9% cost of capital in the initial seven years of the field.

Key Catalysts

Leverage on crude oil prices. If crude were to remain at USD70/billion in the long term, our price target would move to Rs210/share. Resolution of pipeline logistics.

Key Risks

Execution: Cairn faces the challenge of executing its projects in a timely manner. Crude volatility: Global crude prices are cyclical and volatile, so Cairn’s earnings, too, may correlate with sector cyclicality. • Crude oil sales agreement and pipeline logistics still not set.