Cairn India’s focus is clearly back on drilling to further tap the Rajasthan resource—450 wells including 100 exploration wells planned over three years; two new rigs to join in the first quarter of calendar year 2013, taking the count to six; while the management’s plan is to contract five more in FY14, according to a Nomura Equity Research report

Cairn India reported PAT (profit after tax) of Rs25.6 billion for the fourth quarter of FY13 which was in line with Nomura’s forecast of Rs25.9 billion, but was 8% below Bloomberg consensus. EBITDA was flat q-o-q, but PAT fell 23% q-o-q due to higher exploration costs (dry well write-off in Sri Lanka, 3D seismic in South Africa) and higher forex gains in 3Q.

The company remains confident on 200-215kbpd FY14F exit guidance. (Mangala to maintain 150kbpd, Bhagyam reaching 40kbpd in 2H, Aishwariya reaching 10kbpd, and balance from Barmer Hill—the Field Development Plan (FDP) approval still awaited).

Cairn India’s focus is clearly back on drilling to further tap the Rajasthan resource (450 wells including 100 exploration wells planned over three years; two new rigs to join in the first quarter of calendar year 2013, taking the count to six; while the management’s plan is to contract five more in FY14). Cairn is targeting net capex of $3 billion over three years ($1 billion each year; 80% in Rajasthan). Even as its capex target looks ambitious (total gross investment of $3.8 billion until date in Rajasthan), Cairn would have plenty of cash left, according to Nomura Equity Research ($3 billion cash in hand, and likely to generate

Around $5.6 billion cash from operations over three years).

Nomura is more conservative on the Rajasthan block production profile and assumes higher capex in line with the new guidance. It assumes further ramp-up to only 230kbpd (earlier 245kbpd; company target 300kbpd) and also assumes sharper declines. The brokerage has FY14/15F EPS to decline by 2%-4% and has conservatively assigned a 17% discount to cash (in line with current dividend distribution tax).

Nomura highlights the following points from Cairn management’s conference call after announcing its 4Q numbers:

• Reported PAT of Rs25.6 billion (up 17% y-o-y, down 23% q-o-q) is in line with the brokerage’s estimate of Rs25.9bn, but 8% below Bloomberg consensus.

• Sequentially, production declined 1% and EBITDA decline was also 1%.

• Key reasons for the 23% decline in PAT q-o-q include: (1) higher exploration cost (dry well write-off of Rs2.7 billion and Rs0.7 billion expensed on 3D seismic in South Africa and

(2) large forex mark-to-market gains booked in 3Q, offset by higher other income in 4Q.

• FY13 EPS increased by 51% y-o-y, driven by a 32% increase in the Rajasthan RJ block production.

• The company announced a final dividend of Rs6.5 per share. Including interim dividend

(Rs5/share) the total dividend payout was 21.2%, which is in line with the 20% guidance.

• The company recently renegotiated the sales contracts with domestic refiners (for over

200kbpd). Based on improved pricing, Cairn has lowered its guidance on quality discount for the Rajasthan crude from earlier 10%-15% to now 8%-13%. Based on the brokerage’s numbers, Nomura assumes a discount of 13%, which is at the upper bound of indicated range.

According to Nomura, Cairn management again reiterated Rajasthan block production guidance of 200-215kbpd for FY14.

• Mangala – Cairn expects to maintain the currently approved peak production rate of

150kbpd. Of the approved 162 development wells, 157 wells have already been drilled.

In addition to five wells, Cairn is planning 48 infill wells, for which operating committee approvals are in place. These infill wells would later be used for EOR purposes.

• Bhagyam – While well deliverability has been below expectations, in place volume has surprised management positively. Of the 81 wells approved in FDP, 66 wells have been drilled. Apart from balance 15 wells, capex approvals are in place for further 15-18 wells. With additional around 30 wells (with higher deliverability) the company expects to reach approved rate of 40kbpd in 2H FY14.

• Aishwariya – Production started in March 2013. To date, 11 development wells have been drilled, and two have been brought into production. With initial results in line with the management’s expectations, Cairn India expects to reach approved 10kbpd in a few months.

• Barmer Hill – The company has submitted the FDP, and expects production to commence in FY14, subject to FDP approvals.

According to the Cairn India management, the company seems focused on tapping the Rajasthan block upsides. To expedite the approval process, the company has proposed to have an integrated development plan approach to the Rajasthan block, with annual capex approvals, rather than current tedious system of field wise approvals. The company has also recently applied for extension of PSC period in line with PSC guidelines.

• Management is targeting over 450 wells in the next three years—these include 100 exploration wells and over 350 development wells.

• Cairn currently has four rigs (two drilling and two completion rigs). Two more rigs are scheduled to join in 1Q CY2014, taking the count to six. In addition, the company is planning to contract further five drilling rigs, taking total rig count to possible 11.

• Over the next three years the company is targeting capex of $3 billion ($1 billion each year, with 80% in the Rajasthan block). The capex target looks ambitious. Nomura believes that compared to planned net investment of $3 billion over the next three years, total gross investment in the Rajasthan block to date has been $3.8 billion.

• Despite the large indicated capex, Cairn would continue to have significant cash in hand. It is a zero debt company, and has cash balances of $3 billion. Nomura expects Cairn India to generate cash-flow from operation of $5.6 billion over the next three years.

Nomura maintains that despite ambitious capex targets, there remains enough scope to raise dividend payout (payout in FY13 at 21.2% including dividend distribution tax) and/or share buyback (the brokerage believes that the share buyback would be a good venue to buy back the remaining 10.3% stake held by Cairn Plc).

Nomura Equity Research has adjusted its model for actual FY13 numbers. It has reduced its FY14/15F EPS estimate by 2% and 4%, respectively driven by lower production and higher provisions for exploration related write-offs and partly offset by higher other income.

The brokerage has marginally reduced its near-term production estimates. Its revised average Rajasthan production for FY14 is 188kbpd (from 190kbpd) and for FY15 is 216kbpd (from 215kbpd). It assumes RJ production to exit FY14 at 200kbpd in-line with lower bound of management target range of 200-215kbpd.

With higher exploration capex, exploration write-offs for dry wells would likely increase. Nomura assumes higher exploration write-offs of Rs14 billion (earlier Rs 2.5 billion) for FY14 and Rs15 billion (earlier Rs5 billion) for FY15F.

Nomura continues to value Cairn India on a sum-of-the-parts (SOTP) valuation methodology. As per this methodology, the brokerage has calculated the NAV of key fields under production—MBARS (Mangala, Bhagyam, Aishwariya, Rageshwari & Saraswati) and 20 other key discoveries (mainly Barmer Hills) using a discounted cash flow (DCF) methodology. The brokerage was earlier valuing recoverable resources in these 20 other discovered fields ((178mmboe - Cairn share 70%) at $6/boe (use 50% recovery).

Nomura’s NAV for these discovered fields is Rs202 per share (earlier Rs229/share). It is more conservative on the Rajasthan block production profile, as it assumes further ramp-up to only 230kbpd (earlier 245kbpd; company target 300kbpd) and also assumes sharper declines.

Nomura continues to value prospective resources of 1.9bboe (assume 10% recovery) at $6/boe. We assign a value of $6/boe to exploration upsides (prospective recoverable resources of 530mmboe—Cairn share of 371mmboe —Assume 50% recovery).

Nomura values large net cash at 17% discount (in line with current dividend distribution

tax). Earlier the brokerage was valuing cash at book value.

Its SOTP based NAV for Cairn India is Rs351/share while its revised target price is Rs350.

According to the brokerage report, Cairn India could face the following downside risks

• Delays in government approvals and delays in production ramp-up.

• Lower-than-expected oil prices and higher discounts for waxy Rajasthan crude

• Further increase in cess on oil production.