While we remain enthused about the exploratory potential that Cairn India Limited’s (CIL’s) portfolio holds, we do not expect significant news flow relating to incremental reserve accretion in the immediate future (next two quarters) coming in from the company.
We believe that the commissioning and stability of the MBA field production would the company’s prime focus over the next few months. Hence, aggressive exploratory work would take a back-seat.
Reports suggest that CIL has begun test runs of its wells in its Rajasthan block and is expected to commence production by month-end.
We, however, are maintaining our assumption of commencement of ’first oil’ from the MBA field from Q3CY09, at an initial production rate of 30k bopd. We model for a plateau of 185k bopd from these fields, expected to be achieved by 2011.
We believe that peak production could eventually increase to 190-200k bopd, given that the Southern Fields (Raajeshwari, Saraswati) have a production potential of 10k-15k bopd (marginal impact on fair value).
Issues pertaining to cess liability and crude off-take/pricing continue to remain unsettled.
Reports also point out that PSU refineries (IOC, MRPL, and HPCL) have expressed their willingness to buy only one-third of the output, given their limited refining capacity to process the waxy crude.
Pricing discounts, on the other hand, range from $11-$21/bbl. However, clarity is yet to emerge on the same. We continue to assume a cess of Rs927/tonne (current rate Rs2,575/tonne), and pricing discount of 10% to Brent.
Outlook and valuation
We increase our NAV-based target price from Rs220 to Rs235, driven by reduction in our risk-free rate from 8.25% to 7.0%; consequently, our cost of capital now drops from 12.7% to 11.6%.
However, the stock rally of 17% last week, induced by 18% surge in crude prices, implies an 8% upside from the current levels.
Given our view that crude would trade in the $35-$50/bbl range for CY09E, we expect a cool-off from the current levels of $57/bbl.
We downgrade the stock from Buy to HOLD as the stock offers limited upside from the current levels. We note that at the current market price of Rs217, the stock is discounting crude prices of $66/bbl to perpetuity (incl. exploratory upside).