>CAIRN INDIA (KOTAK SECURITIES)

Crude power. Cairn’s stock price has rallied strongly over the past four weeks driven by (1) the surge in global crude prices and (2) higher resources in its main Rajasthan block. We highlight that the current stock price is discounting US$93/bbl in perpetuity, which makes the risk-reward balance unfavorable, in our view. We maintain our SELL rating given potential downside of 19% to our 12-month DCF-based target price of Rs250. Key upside risk stems from the continued surge in crude price.

Current crude price not material for valuation; we assume long-term crude price of US$80/bbl
The recent rally in stock price (+17% since March 1, 2010) has been led by (1) a sharp rise in crude prices which have increased by US$9/bbl (+12%) over the same period and (2) higher resource base. We note that Cairn stock has very high correlation to crude oil prices, particularly since it is the only available play on crude oil prices in India currently. However, we would highlight that near-term crude oil prices do not have a material impact on Cairn’s valuation. We already factor long-term crude price (FY2013E and beyond) at US$80/bbl.

SELL, noting 19% potential downside to one-year fair valuation of Rs250
We find it very hard to justify Cairn’s current prices without assuming very high crude oil prices in perpetuity. We have given up trying to make sense of crude oil prices since there appears to be no links between fundamentals and prices. However, we highlight that Cairn’s current stock price is discounting US$93/bbl in perpetuity based on (1) recoverable reserves of about 1.4 bn bbls in its key Rajasthan block and (2) exchange rate of Rs45.3/US$ in the long term (from FY2013E). Exhibit 2 gives the crude price discounted at various levels of stock price.

A stronger rupee offsets the impact of higher crude prices to some extent
We expect revenues and earnings of Cairn India to be negatively impacted by an appreciation in
the value of the rupee versus the US dollar as it would lead to lower crude price in rupee terms. A Re1/US$ change will impact Cairn’s earnings by about 3-3.5% and would result in FY2011E and FY2012E EPS at Rs19.6 and Rs36.7 versus our base-case EPS estimate of Rs20.3 and Rs37.9.

Earnings revision due to stronger rupee
We have revised our FY2010-12E EPS to Rs6, Rs20.3 and Rs37.9 from Rs5.3, Rs21 and Rs38.7 to reflect (1) stronger rupee and (2) fine-tuned volumes. We have revised our rupee-dollar exchange rates for FY2011-12E to Rs45/US$ and Rs45.25/US$ versus Rs46/US$ and Rs46/US$ previously. We have revised our rupee-dollar exchange rates for FY2013E and beyond to Rs45.25/US$ versus Rs46/US$ previously.

To read the full report: CAIRN INDIA