Our stocks writer delves into the fortunes of Cairn Energy after its tussle with the Indian government.
The situation at Cairn Energy (LSE:CNE) is currently intriguing: where the exploration and production stock is responding only modestly so far, to the Indian government effectively offering $1 billion (£720 million) compensation in a long-running tax dispute going back 15 years.
In recent days, the stock has jumped from a seven-month low 125p to about 175p then encountered selling by long-term holders. Yesterday, it dropped to 160p and is currently 169p.
Oil analysts at brokers differ over the stock’s current net present value but at end-2020 the balance sheet net assets were £812 million 163p a share equivalent.
Following the unexpected news from India, analysts are now targeting 235p to 315p albeit also with the prospect of a chunky special dividend.
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It is possible to question what extent of corporation tax might be due on the award (although Cairn does have losses to offset) but if Cairn was to accept the Indian government’s “offer” then it would represent circa 85% upside on an £840 million current valuation. The market has so far not seen fit to ascribe any value to the claim.
$1.7 billion awarded by international arbitration
Last December, a panel ordered the Indian government to pay Cairn $1.7 billion as compensation for the seizure and sale of a 10% stake in a former Indian operation (Cairn India, renamed Vedanta Ltd (NYSE:VEDL)), also dividends.
The dispute goes back to an internal re-organisation of Cairn in 2006 when it undertook a share transfer in an Indian operation then sold its holding to Vedanta Resources.
In 2014, India the slapped on a tax demand after 2012 retrospective legislation – triggering international arbitration by Cairn for total losses over $1.4 billion. The court awarded it $1.2 billion plus $500 million.
Last March, the Indian government appealed against this “challenge to India’s sovereign right to levy taxes” taking a similar stance against Vodafone (LSE:VOD).
In May, this prompted Cairn to file court actions to seize some of the Indian government’s estimated $70 billion overseas assets – such as international properties, and assets owned by Air India. Yet the management has reiterated an amicable settlement is preferred.
India has finally come off its high horse, for a deal
Its dilemma is having dented foreign investor confidence – just when outside investment is really needed to help the country recover from Covid-19 disruption.
An additional $270 million will go to various international companies including Vodafone; but in order to settle, the affected companies have to accept the principal amount, no interest will be forthcoming.
So, is India offering enough for Cairn now to see reason to settle? Potentially, they could seek more by way of an appeal but which would extend the matter out.
The market’s cautious reaction so far is presumably doubt as to how long it could take for circa $1 billion to actually appear in a bank account, after India has dragged its heels this length of time.
But if Indian lawmakers are to be believed, the lower parliament’s scrapping the 2012 retrospective tax law on foreign investors takes instant effect, with the upper house expected to approve the change imminently this week.
The stock did dip to 160p yesterday morning, as if in reaction to opposition parties staging a walkout of the parliament; but it rebounded seemingly after the leader of the house said the changes were in the national interest.
Now India is engaging “volte face”, it would seem unlikely to further sully its reputation among investors by going back on this.
A chief uncertainty would seem whether Cairn opts to quibble. Yes, it is possible to doubt whether $1 billion is fair restitution given the rupee has depreciated since the confiscation; also, because taxation will be involved to some degree and Cairn has engaged substantial cost and time engaging all this, over years.
But institutional shareholders may weigh on the board to cut a settlement and move on. It is a shrewd gambit by India.
Potential to apply the cash award towards ‘a new Cairn’
The table shows historic big losses, if turning a $155 million net profit in 2019 then a 2020 loss relating to Covid disruption.
So, it might have been that a positive inflection point was reached. Despite good operational cash flow in recent years, chunky capital expenditure needs mean poor free cash flow prohibits any dividends.
Income/cash flow/dividend issues are less important if the development aim is to build assets and sell them on, but the table’s essential overview shows balance sheet net assets halving in recent years.
Poor key financials help explain why the stock has been in a long-term downtrend from over 500p in September 2010, reaching 60p in March 2020 – though it did trade as high as 212p last January.
Yet a major cash injection raises scope to refresh the business with a broader portfolio of interests, at a time when a restructuring is already under way.
With the 2020 results last March, came news of acquiring an Egyptian portfolio of assets from Royal Dutch Shell (LSE:RDSB), in a joint venture with a $323 million net cost to Cairn plus $140 contingent payments according to success.
This, to add about 113 million barrels of oil equivalent of reserves, albeit with two-thirds of production towards gas, which also tilts Cairn’s current hydrocarbon split to gas.
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A cash flow boost is anticipated given the assets net to Cairn achieved $140 million over 2017 to 2019; there being circa 35,000 barrels of oil equivalent per day, production capability, also significant exploration potential remains.
Time will obviously tell, whether assets Shell has chosen to divest, can boost value materially for Cairn, but plenty small to mid-cap E&P companies have developed this way – buying from the majors.
Also, with the results came news of selling two North Sea assets for $460 million plus additional contingent consideration, which “will further strengthen our ability to pursue Cairn’s strategic goals and position the company robustly for the decade ahead".
Money from a prompt Indian settlement would provide a war chest for acquisitions – obviously, much depending on how astute they prove.
Meanwhile, on 2 August, ENI which is the operator of a deep-water well offshore Mexico where Cairn has a 15% working interest, declared a find.
Might the balance of probabilities for Cairn, finally be looking up?
Cairn Energy - financial summary
Year end 31 Dec
|Turnover ($ million)||0.0||0.0||33.3||410||533||395|
|Operating margin (%)||0.0||0.0||-729||-205||29.0||-17.0|
|Operating profit ($m)||-497||-148||-243||-842||155||-67.1|
|Net profit ($m)||-515||-95.0||218||-1135||93.6||-394.0|
|Reported EPS (cents)||-107||-19.6||43.6||-228||24.0||-23.8|
|Normalised EPS (cents)||-61.6||-16.1||60.5||-108||6.7||-20.9|
|Return on capital (%)||-22.7||-6.4||-8.1||-46.0||8.4||-4.5|
|Operating cash flow per share (cents)||-3.1||-4.2||5.8||42.5||81.7||52.3|
|Capital expenditure per share (cents)||67.2||57.4||68.0||61.2||55.3||81.3|
|Free cash flow per share (cents)||-70.3||-61.7||-62.2||-18.6||26.4||-29.0|
|Working capital ($m)||665||352||-39.2||69.5||190||519|
|Net debt ($m)||-603||-335||113||194||131||-335|
|Net assets ($m)||2,099||2,190||2,495||1390||1,456||1,126|
|Net assets per share (cents)||430||448||505||279||292||226|
Source: historic company REFS and company accounts
Brokers’ analysts scramble to upgrade
Berenberg, the German broker, has raised its target from 170p to 235p but they note also potential for a further circa 50% upside – i.e. over 350p.
Peel Hunt has upgraded to 225p from 130p, also its stance from 'hold' to 'buy', likewise Investec which targets 275p. Barclays look for 315p.
While these targets can appear conservative relative to the scale of potential cash injection, there is also the prospect of a special dividend.
Before the news, Peel Hunt had set an actual target price of 130p a share – to reflect various risks on delivery, versus its NAV estimate of 172p a share.
Plenty remains speculative here but a settlement of the Indian dispute does finally look in the offing which tilts risk/reward attractively at 173p currently. Buy.
Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.
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