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Cairn: a rare low-risk oil play

For UK investors keen to get into a dollar-earning London-listed stock, Cairn promises significant upside
June 30, 2016

Amid the sell-off in equities in the past week, UK investors could do worse than picking through the rubble for large, defensive dollar-earning - or soon-to-be dollar-earning - stocks. Oil and gas companies offer a neat solution to this quandary, although the turmoil in energy markets has left serious questions over the large producers' reserves and balance sheets, given their determination to pay dividends at seemingly any cost. In light of that risk, one company we think investors should consider is Cairn Energy (CNE), the FTSE 250 explorer with superb pre-production assets in offshore Senegal and the North Sea. For those looking for a low-risk oil exploration stock with major discovery upside and excellent dollar reserves, Cairn fits the bill.

IC TIP: Buy at 190p
Tip style
Growth
Risk rating
Low
Timescale
Long Term
Bull points
  • Upside risk to resource estimates
  • Cash-rich
  • Low-cost production
  • Potential favourable tax settlement
Bear points
  • Counterparty and execution risks
  • Oil-price volatility

One reason for this low risk profile is that, unlike many peers, Cairn has not spent the past two years selling oil at unprofitable prices, booking massive impairments and taking on debt. This is reflected in the company's share price, which has outperformed the sector. Instead, Cairn has been investing while others have been retrenching to build its asset base from 30m barrels (mmboe) of booked 2P (proven and probable) reserves at the end of 2013 to 49.5mmboe of 2P and 196.5mmboe of 2C (contingent) resources at the end of last year. Crucially, that omits huge additional reserves the company believes it has found through twin discoveries off the coast of Senegal, which occurred in 2014.

 

 

Cairn's exploration drilling in the Sangomar Deep Offshore block in Senegal - in which it holds a 40 per cent working interest - has been very positive so far. By December 2015, the company estimated it had an even chance of recovering 385mmboe from the block, a figure that should jump when half-year results are published in August, now that a trove of data has been collected in the recent drilling programme. Analysts at JPMorgan expect that drilling - currently paused - will recommence in late 2016 or early next year, ahead of a commercial decision on the block.

In the meantime, Cairn is putting its $603m (£450m) cash pile to use on its interests in the North Sea, which centre on the Kraken and Catcher fields. By 2017, Cairn hopes that the two sites will be generating positive free cash flow, with peak net production to Cairn of around 25,000 barrels of oil equivalent per day. First production should come at Kraken early next year, $300m under budget, ahead of schedule and boosted by the February acquisition of an additional 4.5 per cent interest in the development following the collapse of joint-venture partner First Oil. The field, which should last 25 years, is expected to break even at around $14 per barrel at peak flow. Production from Catcher - which is expected to break even at prices of $20 per barrel and is being developed with fellow North Sea explorer Premier Oil (PMO) - should follow soon after, now that the project has completed subsea installation work and hull and integration work is due to begin.

That combined capital outlay is likely to wear down Cairn's net cash position in the next year, although the company has an undrawn reserve-based lending bank facility of up to $335m, with additional letters of credit of $175m also available. Importantly, this provides a backstop if any of Cairn's counterparties run into money problems.

One potential fillip to that cash position - and the share price - is the settlement of a dispute with Indian tax authorities. India's revenue has claimed it is owed $477m, and blocked Cairn's disposal of the residual 10 per cent stake it holds in Cairn India, the division the company sold to Vedanta Resources for $6.5bn in 2011. Cairn has a "high level of confidence" it can claim compensation of $1bn in the matter, which has reached international arbitration under the UK-India Investment Treaty. A conclusion of the dispute is unlikely to happen this year, but because the shares do not currently price in a win, investors could receive further upside.

CAIRN ENERGY (CNE)

ORD PRICE:190pMARKET VALUE:£1.1bn
TOUCH:190-191p12-MONTH HIGH:232pLOW: 125p
FORWARD DIVIDEND YIELD:nilFORWARD PE RATIO:na
NET ASSET VALUE:364¢*NET DEBT:$603m

Year to 31 DecTurnover ($bn)Pre-tax profit ($bn)Earnings per share (¢)Dividend per share (¢)
2013nil-1.10-93.2nil
2014nil-0.56-65.0nil
2015nil-0.50-89.0nil
2016**nil-0.13-0.20nil
2017**251-0.08-0.14nil
% change----

Normal market size: 10,000

Matched bargain trading

Beta: 1.17

£1=$1.32

*Includes intangible assets of $555m, or 96¢ a share

**JPMorgan forecasts