Also see, about share pledge of Cairn India – Comments section here.

I think if India has to emerge as a stronger nation, it must find ways to reduce dependency of foreign oil and find ways to become meet its energy requirements. Cairn India’s stock price tanked over 11% in the two trading sessions (on – 24^th & 25^th July 2014) after the Company announced its Q1 numbers for FY 2015.

While the company may or may not hit big oil reserves anytime soon, here is what is going for Cairn India:

• ~ 55k Cr. In accumulated reserves.
• Zero debt on its books.
• Operates in a sector critical for India’s progress. The Government has every reason to make sure that companies like Cairn should success.

So why exactly did the stock price tank like that?

Here is what is going against Cairn India:

• Cairn India changed its depreciation policy which resulted in a 65% reduction in the net profit – Personally, I am not so sure on how and why this impacts the overall business of the company, nor am I particularly impressed with the timing of this change. Though I believe that the accountants may have had a solid reason to do this to achieve some tax advantage. Interestingly Cairn India also withdrew its suit against the retro amendment to the Income Tax Act, which imposed tax liabilities on offshore transactions for a prior period on the same day it announced it Q1 results.
• An even more extreme measure was to extend a US $1.25 billion loan to its parent – Vedanta group for 2 yrs at Libor+ 300 basis points. With the current LIBOR, this comes to ~ 3.5% p.a. Of course this is something Vedanta group could not have found elsewhere. The question to ask is – “Were any efforts made to extend this money to another corporate (or elsewhere) where it could have fetched a higher rate of return with equal or lesser risk”. Did the board of Directors honestly perform the duty they owed to the company and to its shareholders?

Something that makes the whole situation look worst than what it is (or could have been) is that the company has given every indication that it has run out of ideas and has no clue how to deploy the funds effectively.

First, Cairn India announced a buyback of 8.9% of the equity from open market (this was back in January 2014). At the buyback price of Rs. 335 a share, Cairn India could buy back ~ 2%.

Usually, a buyback is announced when the Company believes that the share is quoting below its real worth, and it may be a good time buy back to increase shareholder value by reducing the number of issued share capital. If one were to be harsh, you could say that a buy back is announced when the management runs out of ideas on how to use its excess cash, does not want to expand and does not want to give the money out as dividends to shareholders.

Second, it almost seems like that since Cairn India could not utilize the excess cash in buying back its shares, it decided to extend a huge loan to its parent. Here is a management shouting, screaming literally – we don’t know what to do with this cash.

This is a company which did not pay dividend to shareholders citing need for funds in future.

How about the Parent increasing its holding in Cairn?

How about this – Vedanta now starts buying shares in Cairn India with the loaned money (and pays back the loan in a couple of years by selling the same shares at a much higher price).

No matter what explanation does Cairn India come up with now, it will find it hard to justify this move? It almost seems like conditioning to ensure that the stock price falls to a level at which the management will be comfortable in buying some of the shares which it could not do in the buyback offer. Here are the 2 announcements again – (a) change in depreciation method to reduce profitability by 65%; and (b) a ridiculous loan to the parent company.

At the current price, the only people buying into Cairn India I believe are those who wanted to see it at Rs. 308 (read – insiders).

A cause for concern?

A look at the shareholding pattern of Cairn India would reveal that there are hardly any small (retail) investors left in the company.

Out of the 13.47% holding with others, 9.82% is owned by foreign corporate bodies. So roughly, small investors hold ~ 3.5% shareholding in Cairn India.

Given this scenario, if a few big fund houses (DIIs or FIIS) decide to sell this stock citing bad corporate governance, then this could trigger a race to the bottom.

For now, this is unlikely to happen though. Most investors who have bought this share at a higher level will wait for it to rebound back to those levels. The problem is this – if they get those levels back, and are able to sell and exit, would they then reinvest in a company with the kind of corporate governance standard that Cairn India has exhibited? I can’t answer in a simple ‘yes’ or ‘no’. It may still depend on many other considerations.

Also Read: Vedanta Cairn Merger: The Good, Bad and the Ugly

Detailed Stock Analysis of Cairn India

Cairn India Limited (“Cairn India” or the “Company”) is one of the largest oil and gas exploration and production companies in India and is engaged in various related businesses including exploring, refining, trading, transporting and marketing of oil and gas. The Company also deals in minerals and oil and gas related by-products. Cairn India’s producing assets are in Rajasthan, Cambay (Gujarat) and Ravva (Andhra Pradesh).

The Company has a total of 10 blocks/fields in its portfolio. The Company is participant in various oil and gas blocks/fields (which are in the nature of jointly controlled assets), granted by the Government of India through production sharing contracts.

WHAT’S DRIVING THE STOCK

Strong Financial Position

Cairn India has shown consistent growth over the last five years (i.e. 2010-11 to 2014-15). Its net revenue from operations over this period grew at an impressive CAGR of 7.34%. The Company has reserves in excess of Rs. 56,995.35 Cr and OPERATES WITH ZERO DEBT on its books. This strong financial position has enabled the Company to expand its operation in a subdued economic environment.

 At CMP of Rs. 128.70 (11th January, 2015), Cairn India is trading at a P/E of 9.22x and has a dividend yield of 6.99% at current market price.

The Company has maintained an average dividend yield of 2.58 % over the last 5 financial years.

Liquidity and Credit Analysis

Cairn India’s average current ratio over the last 5 financial years has been 4.74 times which indicates that the Company is comfortably placed to pay for its short term obligations.

Cairn India’s average long term debt equity ratio over the 5 financial years has been 0.01 times which indicates that the Company operates with close to zero debt and is placed well to withstand economic slowdowns.

Cairn India’s average interest coverage ratio over the last 5 financial years has been 201.62 times this indicates that the Company can meet its debt obligations without any difficulty.

Promoters hiking stake

On 23^rd January 2014, the Company commenced a buyback of its equity shares at a price not exceeding Rs. 335 per equity share for an aggregate amount not exceeding Rs. 5,725.00 Cr.  The buyback issue closed on 22 July 2014. During the Buyback period, the Company bought back 36,703,839 shares for a total consideration of approximately Rs. 1,225 Cr. from the open market through stock exchanges.

An increase in promoter stake is a strong reaffirmation by the insiders, who are the first recipient of any information and knowledge, that there is greater potential value in the business than what the market is paying for it.

Expansion Plan

Cairn India has started implementation of three major development projects in the Rajasthan block – (i) Polymer Flood Enhanced Oil Recovery (EOR), (ii) Barmer Hill (BH) development; and (ii) a gas development project. Gas potential in the Rajasthan block presents a unique opportunity for Cairn India to establish itself as a key player in the Indian natural gas market. The Company plans to make an investment of US$ 3 billion over the next three years i.e. FY 2015-17. This expansion is expected to deliver a growth of 7 % to 10 % in production over the next three years.

On the back of this expansion plan, in our analysis. Cairn India is well positioned to grow its revenues and profits over the next few years.

Government Reforms in Petroleum Product Pricing

The new NDA led government has shown both intent and commitment towards reforms in the oil and gas sector. Any reforms in the  sector and any future price hikes in petroleum products like diesel, LPG and kerosene would add significantly to Cairn’s earnings.

WHAT’S DRAGGING THE STOCK

Risks Related to Execution of Projects

Cairn India’s expansion projects have long execution timelines with interdependencies. To successfully execute the project, the Company has to rely on multiple equipment and services providers and construction contractors across sites spread over a wide geographic area. Ensuring timely delivery of such services and equipment at the right cost, managing materials at remote sites, while simultaneously ensuring that all compliances are met can pose potential challenges.

Any delay in the commissioning of projects is a concern for the Company as it leads to delay in inflow of revenues. At the same time, company has to incur costs on the delayed projects, thus affecting margins and overall profitability which could have a negative impact on the share price.

Regulatory Policy

The Company’s business will be affected by the changing regulatory policies such as any political developments by the central, state, local laws and regulations such as production restrictions, changes in taxes, royalties and other amounts payable to the various governments or their agencies. Any adverse political developments, laws and adverse changes in the regulatory environment will naturally have a negative impact on the overall profitability of the Company.

Currency Fluctuation – Appreciation of Rupee against the US $

Cairn India remains exposed to the risk of foreign currency fluctuations. Foreign Exchange markets continue to be volatile and have witnessed severe movements in both directions over the last few years. The Company’s realizations are denominated in U.S. Dollar terms and thus it remains exposed to the risk of rupee appreciation vs. the U.S. Dollar.

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Rajat Sharma

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