>CAIRN INDIA: Alert: Second KG Onshore Discovery; Encouraging Prospects

■ KG basin discovery: +ve, but materiality to be established over time — Cairn has announced its second oil discovery (out of 6 wells drilled) in its onshore KG basin block KG-ONN-2003/1 (Cairn – 49%, ONGC – 51%). As per management, this represents the largest onshore discovery in the KG basin, and total oil in-place from both discoveries is expected to be in excess of c550 mmboe. However, given the tight reservoir, recovery factors are likely to be low (c10%), which could increase over time with fracking. Management indicated that the good quality of crude (light oil, low viscosity) could aid in development and recovery, though the decision to go in for development, and eventually production, could still be some time away. Based on an EV/boe of US$7-8 (we now value Rajasthan upsides at US$8.5/boe, a 25% discount to the imputed EV/boe for core MBA), this could add ~Rs5-6/sh to our NAV for Cairn.


■ Rajasthan production potential of 500 kbpd? — As per a press article (source: Hindustan Times), Vedanta Chairman Mr. Anil Agarwal has written to the Prime Minister’s principal secretary Mr. Pulok Chatterjee that production from Rajasthan could reach c500 kbpd in the next few years (c150 kbpd currently). At this stage, these targets appear fairly ambitious to us, with several imponderables (geology being the primary one), and we would refrain from getting overly excited at this stage. Cairn India's guidance now stands at peak production of c240 kbpd (with a ‘significant part’ of this from MBA), while Cairn Plc has in the past indicated that this could potentially go up to c300 kbpd. Our current forecasts assume peak MBA production of 230 kbpd (by Dec’13E). Nevertheless, production growth of the envisaged magnitude, if indeed possible, would not only be an obvious +ve for longer-term volume growth but would also likely require significant incremental capex, potentially partially mitigating longerterm concerns on use of cash.


■ Reiterate Buy — Our target price of Rs380 is based on an average of Citi’s crude forecast-based NAV (crude at US$125/120 over CY12/13E; long-term of US$80), which yields a value of Rs383/sh, and the forward curve-based NAV, which yields a value of Rs414/sh. We build an additional 5% discount to NAV to account for uncertainty regarding use of cash. We reiterate Buy on the stock which, in our view, offers the best hedge against crude, currency, and (to some extent) inflation. Key near term catalysts are approvals for Mangala ramp-up and expected dividend policy announcement. Cairn remains our top large-cap pick in the sector.


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