Research firm Motilal Oswal Securities has recommended buy rating on Cairn India with target price of Rs 163. Research firm values Cairn's Rajasthan block (including EOR) and its currently producing blocks (Ravva and Cambay) on DCF basis and Cairn’s stake in the KG block based on announced 2P reserves of 2.09TCF.

Pipeline concern getting resolved:

Resolution of the pipeline issue will enable monetisation of Cairn's largest and most promising asset, Rajasthan block by 2HCY09. Though, there still remain several uncertainties on cess, pricing and crude offtake, we believe these will not hamper the initial oil delivery schedules. Successful development of Rajasthan block, which will catapult Cairn into bigger league, will be the key driver to its performance, in our view.

Rajasthan block; already a world-class oil asset; holds promise
for more:

The Rajasthan block RJ-ON-90/1, is Cairn's main asset accounting for 80% of its total reserves. Of the total current gross inplace resources of 3.6 b boe, 2.2 b boe are currently in development phase. There remains upside from area already being developed and more development area is being added.

Large exploration acreage provides upside; two producing
assets provide the cash:

Cairn also has large exploration acreage of about 94,800sq km in 12 other blocks, including 5 as operator. The most promising of these is ONGC operated (Cairn 10%) deep water block KG-DWN-98/2. Cairn has successfully extended plateaus for both its operating assets at Ravva and Cambay, by successful infill development and further exploration and development drilling.

Valuation and recommendation

We value Cairn's Rajasthan block (including EOR) and its currently producing blocks (Ravva and Cambay) on DCF basis. We also value Cairn’s stake in the KG block based on announced 2P reserves of 2.09TCF. Upside potential to valuation comes from these blocks as well as other blocks in its stable. We value Cairn on Sum of Parts basis at Rs 163 per share. We initiate coverage with a Buy.

The Rajasthan block, which is set to commence production in 2009, provides 87% of value of our current value. With the block still in early stage of exploration and development, we believe it continues to have significant upside potential. We value Cairn's currently producing assets (Ravva and Cambay) at Rs 16 per share. We assign a value of Rs 5 per share, to Cairn's 10% interest in the KG-DWN-98/2. We do not attribute any value to Cairn's other exploration acreage in 9 blocks, as all these blocks are still in early stages of exploration.

Key risks

Oil prices:

We believe high oil prices are here to stay, and assume the long-term average Brent oil price at USD 55/bbl. We also assume that Cairn's Rajasthan crude will be sold at 10% discount to Brent. A lower oil price environment and/or higher actual discounts for Rajasthan crude pose downside risk to our estimate.

Cess:

We assume Cairn will be required to pay cess (levy) of Rs 927/MT v/s the current cess rate of Rs 2,675/MT (including education tax and NCCD cess). Cairn believes it is not liable to pay any cess and is currently contesting cess payment with the GoI on the issue, and indicates that in case of an adverse decision, Cairn will opt for arbitration. Higher cess payment than our estimate will be negative for Cairn by Rs 18 per share; similarly if Cairn is required not to pay any cess, it will be positive by Rs 12 per share.

Pipeline:

We assume that GoI will approve Cairn and ONGC's jointly planned pipeline to evacuate Rajasthan crude. We also assume that the pipeline will be included in FDP for the Rajasthan block. Based on these assumptions, we assume Cairn to begin production from the Rajasthan block in October 2009. However, any significant delays in final approval of the pipeline and/or non-inclusion of pipeline cost in FDP will be negative for our estimates.

EOR:

The company has indicated that it plans to utilize EOR techniques to enhance production rates and plateau periods. In our estimates we assume recovery of 196mmboe (Cairn share 138mmboe) through EOR. Currently the company is testing EOR techniques at laboratory levels. Non-implementation of EOR, or lower recovery of oil through EOR, will result in downside to our estimates. We currently value EOR recoveries at Rs 19 per share.