Narrow moat-rated Cairn India's fourth quarter was disappointing.
The 47% revenue decline largely reflected lower crude prices, but net profit of Rs 2.4 billion was well short of our Rs 6.8 billion estimate. Downbeat management commentary implies flat volume growth till 2017, largely reflecting the lower oil price. Excluding Rs 3.7 billion in exploration writeoffs for two dry wells, net profit would have met our expectations.
Forecast improvement in crude prices implies fiscal 2016 will be better than the fourth quarter of fiscal 2015.
We have cut our five-year average volume growth estimate to 4.2% from 4.7% on lower planned capital outlays. We believe forecast growth is consistent with our long-term Brent crude forecast of $75 per barrel. However, the above change is not material enough for us
to change our Rs 300 per-share fair value estimate.
We believe Cairn's shares are undervalued owing to two regulatory uncertainties: extension of the oil and gas field lease period, and a tax demand of Rs 200 billion. We
think it's likely the market overestimates these risks, as regulators have given the nod to the commercial gas production as a precursor to field extension approval. In our view, Cairn faces real risk of only about Rs 50 billion as tax levy, implying about INR 23 downside to our fair value estimate.
Cairn’s narrow economic moat is underpinned by the onshore Rajasthan block, which is its dominant revenue source, with extremely low operating costs of about $6 per barrel. Cairn's high fair value uncertainty rating reflects its exposure to cyclical crude prices and the uncertainty around future capital investments, particularly with the company intending to move into offshore exploration and production, where competition is high and Cairn lacks competitive advantage.
Our unchanged Poor stewardship rating reflects concerns around poor capital allocation, notably the loan to a major shareholder, offshore forays, and its low dividend payout.
