>CAIRN INDIA LIMITED (KOTAK SECURITIES)

■ Downgraded to SELL. We would advise investors to book profits in Cairn India stock
noting potential muted stock performance led by (1) likely weakness in crude prices, (2) negative development on cess issue and (3) concerns on execution and production ramp-up from its key Rajasthan block. We have downgraded the stock to SELL, noting the stock offers potential downside of 15% to our revised 12-month DCF-based target price of Rs230. Key upside risk stems from higher-than-expected crude prices.

■ Likely near-term weakness in crude price will result in muted performance
We expect muted stock performance for Cairn in the near term led by (1) likely weakness in crude prices and (2) potential negative development on the cess issue. We expect crude prices to remain weak over the next quarter led by (1) seasonally weak global demand in 2QCY10, (2) high inventory levels (59 days of forward cover), (3) potential slippage in OPEC compliance (down to 58% in January 2010) and (4) simultaneous start of several delayed NGL projects in CY2010E (see our report titled ‘Crude price outlook: Expect short-term weakness’ released on March 3, 2010). We note that the Cairn stock has very high correlation with crude price (see Exhibit 1).

■ Stock discounting US$93/bbl in perpetuity; large downside risk to our target price of Rs230
We have downgraded Cairn India to SELL from REDUCE noting that the stock is trading significantly above our revised 12-month target price of Rs230 (potential downside of 15% from the current stock price). We highlight that the current stock price is discounting US$93/bbl in perpetuity based on (1) recoverable reserves (about 1.1 bn bbls) from its key Rajasthan block and (2) exchange rate of Rs46/US$ in the long term (from CY2013E). We highlight that the current stock price is ascribing US$1.7 bn as the option value of new discoveries/upgrade of reserves.

■ Revised earnings and valuation for cess payment, budget-related changes
We have revised our 12-month DCF–based target price to Rs230 (from Rs265 previously) to reflect (1) payment of cess at Rs2,575/ton by Cairn, (2) lower discount of US$5/bbl (versus US$6/bbl previously) on account of change in import duty on crude to 5.15% from nil previously in the Union Budget 2011; we may be too lenient on the discount at 6% of long-term Dated Brent price and (3) higher MAT rate of 19.9% versus 17% previously. We have revised our FY2010-12E EPS to Rs5.4, Rs17.8 and Rs35.3 from Rs6, Rs20.9 and Rs42.7 to reflect the above-mentioned changes. Key upside risks to our valuation and earnings stem from (1) higher-than-expected crude price, (2) higher-than-disclosed reserves and (3) favorable outcome of the cess issue; key downside risks stem from (1) lower-than-expected crude price and (2) slower-than-expected ramp-up in
production from Rajasthan block.

To read the full report: CAIRN INDIA