Cairn India: Concerns go beyond oil prices

Cairn India Ltd has announced results for the quarter ended December 2014. The topline registered 29.9% decline on a year on year (YoY) basis during the quarter while bottomline declined by 53% YoY. Here is our analysis of the results.

Performance summary

• Topline for the quarter declined by 29.9% year on year (YoY). In dollar terms, the revenues declined by 30% YoY
• The operating profits for the quarter declined by 43.6% YoY, with margins at 57.8% versus 71.8% in 3QFY14.
• The firm registered a decline of 53.2% YoY in the bottomline during the quarter with net profit margins at 38.5% versus 57.7% in 2QFY14. In dollar terms, the decline came in at 53% YoY.
• Gross capex for the quarter stood at Rs 18.6 bn, mainly led by development and exploration activity in Rajasthan block.
• Gross production during the quarter stood at 20 million barrels.

Standalone financial snapshot

Rs m	3QFY14	3QFY15	Change	9mFY14	9MFY15	Change
Sales	50,000	35,041	-29.9%	137,128	119,690	-12.7%
Expenditure	14,081	14,772	4.9%	37,102	42,341	14.1%
Operating profit (EBDITA)	35,919	20,269	-43.6%	100,026	77,349	-22.7%
Operating profit margin (%)	71.8%	57.8%		72.9%	64.6%
Other income	1,403	1,629	16.1%	3,567	9,273	160.0%
Interest	91	84	-7.5%	306	152	-50.3%
Depreciation	5,948	8,909	49.8%	16,607	23,135	39.3%
Forex gain/(loss)	-1,290	3,536	nm	9,821	6,927	-29.5%
Profit before tax	29,992	16,440	-45.2%	96,501	70,262	-27.2%
Profit before tax margins (%)	60.0%	46.9%		70.4%	58.7%
Tax	1,152	2,944	155.5%	2,537	6,784	167.4%
Effective tax rate (%)	3.8%	17.9%		2.6%	9.7%
Profit after tax  before exceptional items	28,840	13,496	-53.2%	93,964	63,478	-32.4%
Net profit margins before exceptional items (%)	57.7%	38.5%		68.5%	53.0%
Exceptional items net of tax					16,274
Net profits post exceptional items	28,840	13,496	-53.2%	93,964	47,204	-49.8%
Net profit margins post exceptional items(%)	57.7%	38.5%		68.5%	39.4%
No. of shares					1,875
Diluted earnings per share (Rs)*					41.4
P/E ratio* (x)					5.7

What has driven performance in 2QFY15?

• The net revenues for the quarter declined by around 30% YoY (post profit sharing with the Government of India and the royalty expense in the Rajasthan block) mainly on account of lower realisations as crude prices remained weak. The average price realization for oil stood at US$ 68.1 per barrel, down 28% QoQ. The average daily production declined by 2%, however grew by 12% on a sequential basis.

• The operating profit margin for the quarter declined by 14% (in rupee terms). Apart from lower volumes and weaker realizations, the decline was due to higher production costs, increased exploration write off costs and higher cess and other expenses. The operating costs in Rajasthan block stood to US$ 5.7 per barrel.
  Cost breakup

  Rs m	3QFY14	3QFY15	Change	9mFY14	9MFY15	Change
  Production expenses	2,928	4,618	57.7%	8,293	12,433	49.9%
  as a % of sales	5.9%	13.2%		6.0%	10.4%
  Employee benefit expenses	1,853	324.6	-82.5%	2,267	802.3	-64.6%
  as a % of sales	3.7%	0.9%		1.7%	0.7%
  Statutory levies	7,735	7,274	-6.0%	22,151	21,127	-4.6%
  as a % of sales	15.5%	20.8%		16.2%	17.7%
  Other costs	562	984	75.0%	1,875	2,521	34.5%
  as a % of sales	1.1%	2.8%		1.4%	2.1%
  Exploration costs w/off	1,003	1,572	56.8%	2,516	5,459	116.9%
  as a % of sales	2.0%	4.5%		1.8%	4.6%
  Total costs	14,081	14,772	4.9%	37,102	42,341	14.1%
  as a % of sales	28.2%	42.2%		27.1%	35.4%

  
  
• The net profit for the year declined by 53% YoY despite a forex gain of Rs 3.5 bn during the quarter (as compared to forex loss of Rs 1.3 bn). Apart from a weak operating performance, higher effective tax rate and high depreciation expense (due to increase in production, capitalization of assets and the impact of the accounting policy basis unit of production method) led to the decline in the bottomline.

What to expect?

The company will continue to focus on increased recovery from its fields and infrastructure creation in the core MBA reservoirs. As per the management, gas development continues in line with the target to double gas production through existing gas pipeline by 4QFY15. For the quarter, the capex stood at Rs 15 bn, most of which went into development projects and exploration in Rajasthan. For the nine months ending December 2014, the capex stood at Rs 48 bn. As per the management, so far, the company's capex plans (US$ 3 bn for three years) pass the hurdle test rate and payback within 2020.

The quarter ended with cash worth Rs 178 bn on company's books. The management has reiterated that it will focus and ensure positive cash flows even in a weak price scenario.

For incremental production from enhanced oil recovery schemes, the management has indicated that the opex could increase to US$ 8 -US$ 12 per barrel. The management has also indicated that the dividend payment is likely to be maintained despite lower profits.

Recently, the state owned ONGC has unconditionally agreed to Cairn India retaining the prolific Rajasthan oil block beyond the contractual deadline of 2020.The Board merely stated that the license can be extended on mutually agreeable terms and asked the government to decide on the issue.

The stock of Cairn India has corrected significantly, mainly on account of decline in the crude prices. While this could have been an attractive buying opportunity from a long term perspective, concerns over cash utilization by the management and restructuring remain a key risk. It is noteworthy that there have been reports that Mr. Anil Agrawal, the promoter of Vedanta Group is considering a merger of two firms - Cairn India (along with Hindustan Zinc) with Sesa Sterlite. While Cairn India remains a cash rich entity, Sesa Sterlite is debt ridden. As such, while the merger, if it happens, might be positive for Sesa Sterlite, is unlikely to be in the best interests of minority stakeholders in Cairn India. As such, we recommend investors to avoid investing in the stock at least till some clarity emerges on the merger front.