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Research
Accumulate Cairn India - Risk-reward turns favourable - Elara Capital
Posted On : 2011-02-22 10:33:42( TIMEZONE : IST )
- Rating: Accumulate
- Target Price: INR360
- Upside: 14%
- CMP: INR316 (as on 18 February 2011)
Vedanta deal dynamics bring stock to attractive levels
The damage inflicted by the Vedanta deal on the Cairn India stock price has made its risk-reward levels favorable for investors, in our opinion. The deal stands at a very interesting stage now, throwing open the following three scenarios. While scenarios 1 and 2 indicate an upside for the stock, scenario 3 though negative leads to limited downside from the current levels, in our view.
1) Deal goes through with (the existing system of) ONGC bearing 100% of the royalty for the Rajasthan block. This seems to an unlikely scenario now considering some of the latest remarks from the Petroleum Minister and ONGC top management on protecting some of ONGC's interests.
Impact: The stock can potentially rally towards its deal value of INR355/share
2) Deal does not go through because of the two parties or the Government.
Impact: Based of our estimates and assumption of 0.9x correlation with crude prices, the stock should have been at INR450/share if the deal had not been announced. If the deal does not go through, we believe that the stock will at least capture half of its lost upside opportunity.
3) Deal goes through with Cairn having to bear 70% of royalty or royalty being made cost recoverable.
Impact: This is likely to have an USD1.7bn (INR40/share) negative impact on the stock/deal value. However, this reduction from the deal value of INR355/share implies price levels of INR310-315/share, close to current levels indicating limited downside prospects.
Corporation action beckons, limited downside: Upgrade
Due to the above scenario-based analysis which suggests a favorable risk-reward, we upgrade Cairn India to an Accumulate rating from Reduce, recommending the outperformance potential from the stock. We are also modifying our valuation methodology for Cairn India. As opposed to our earlier and Street method of only asset-based NPV valuation, we have introduced a 20% weightage each for relative valuation and Cairn's crude correlation dynamics. Our asset-based valuation (60% weightage) gives us a value of INR330/share for Cairn. For relative valuation, we discount our steady state FY13 EPS of INR53 by one year and apply a P/E of 7x. Lastly, crude correlation analysis gives an INR450/share valuation. Combining these three methods, we arrive at our new target price of INR360/share for Cairn India.
