26/3/2013





 Buy Cairn India For Target Rs.370
Post the policy clarity on exploration in producing E&P blocks, Cairn India has recommenced exploration at its Rajasthan block after a 4-year gap. Given the proven prospectivity of the block and aggressive drilling program (100 wells in 3 years) and similar to earlier exploration period, we expect further addition to its reserve potential.
* On the production front, while near-term ramp-up needs to be watched, given the slow ramp-up at Bhagyam and earlier than expected decline in Mangala, the management guidance to achieve FY14 exit production of 200-215kbpd is positive.
* Cairn's large cash balances (USD4.7b by end-FY15; 48% of current market cap) are at higher than optimum levels. Given that the company has no definite large acquisition plans, the management should (a) increase dividend or announce a special dividend, and/or (b) buy back shares to reward shareholders.
* The stock has corrected 19% in last 3 months led by ramp-up concerns and we estimate that the current price discounts long-term Brent price of USD75/88/bbl with/without exploration upsides. We believe that ramp-up concerns will be short-term and with likely reserve accretion, the risk-reward is favorable and upgrade our rating from Neutral to Buy. Our SOTP-based target price is INR370 implies an upside of 33%.
FY14 exit production guidance of 200-215kbpd at Rajasthan, a positive
Despite earlier (4QFY14) than expected natural declines in Mangala field, production is likely to ramp-up from current ~171kbpd (Mangala: 150kbpd; Bhagyam: 20-25kbpd) to 200-215kbpd (management guidance) by the end of March 2014, led by production start at (a) Aishwariya in March 2013, and (b) Barmer fields in 2HFY14. We cut our FY14/FY15 average production estimates by 4%/16% to 182/ 185kbpd, led by assumed decline at Mangala. While near-term production issues have created some ramp-up uncertainty, we do not expect any change in the overall recoverable reserves and maintain our gross recovery estimate at 1.2bboe.
With exploration back on track, expect further reserve addition
Over the years, Cairn has increased the gross in-place resource estimate for its Rajasthan block by ~4x to 7.3bboe and recoverable reserve estimate by 2.2x to 1.2bboe. Now, with 100 exploratory wells planned in three years, we expect further increase in recoverable reserves to 1.7bboe through conversion of 0.5bboe of prospective resources into reserves. We currently model recoverable reserves of 1.2bboe in our valuation and do not assign any value to the likely addition of 0.5bboe.
Valuations attractive; upgrade to Buy, with a price target of INR370 We believe that the current market price of INR278 factors in long-term Brent price of USD75/88/bbl with/without exploration upsides. The stock is trading at 5.6x FY15E EPS of INR49.8 and the implied dividend yield is ~4%. We revise our rating from Neutral to Buy. Our target price of INR370 implies an upside of 33%.
 

Buy Divis Laboratories Ltd For Target Rs.1,276

  

Attractive Entry Point For Investors; Retain Buy
Divis Laboratories (DLL) stock has shed 7% since its 3QFY13 results on concerns over high power costs at its Andhra Pradesh (AP)  operations impacting margins. Our interaction with the company’s management leads us to believe that the market may be overestimating the impact of increased power costs and we believe the current valuation of 16xFY15E EPS (20% discount to its five-year average multiple) provides an attractive entry point for investors. We have factored in our revised inhouse call on the rupee-US dollar rate of Rs52.0/$ (from Rs55.5/$ earlier) in our estimates, leading to a 2% reduction in our FY14E EPS, but retained the Buy rating on DLL with a revised target price of Rs1,276 (from Rs1,302 earlier), valuing the stock at 21xFY14E EPS of Rs60.7 (from Rs62.0 earlier).
Power supply situation grim in AP, but the street overestimates its impact: DLL has witnessed a sharp rise in power costs (up ~160bps YoY as a percentage of sales in the 9MFY13 period), owing to which its margins declined by~200bps consecutively for the past two quarters. Factoring in higher power costs and forex losses, we had revised our FY13E margin assumption downwards by 200bps post 2QFY13 results. While the power supply situation continues to remain grim in AP, we believe our margin assumption of 36% for FY13E (36.5% margin in the 9MFY13 period) provides sufficient buffer from any further fall in margins due to power cost escalation. Further, with a favourable currency movement (average rupee-US dollar rate so far in 4QFY13 at Rs54.1/$ versus Rs50.1/$ in 4QFY12), there can be an upside to our assumptions. As per our estimates, DLL’s operating profit is expected to rise by ~5% for every 10% fall in the rupee.
FY14 may usher in upside in margins: Our interaction with the management indicates that DLL may have to bear escalated power costs in the current quarter, but the margins in FY14 should start improving as the company has already signed a long-term agreement for power supply. Further, with the likely ramp-up at its Vizag facility (post the US Food and Drug Administration or USFDA inspection scheduled in 1QFY14 and subsequent clearance thereof of remaining two blocks of the DSN unit), we believe there exists significant scope for improvement in margins (DSN facility is currently operating at ~45% of its capacity, which is expected to go up to 85% as supplies to the US begin).
Strong FY14 guidance: DLL’s management has reiterated its guidance of a 22%-25% (assuming rupee-US dollar rate of Rs52.5-Rs53.0/$) revenue growth in FY14 (expects to achieve the higher end of its guidance if the USFDA’s approval comes in 1HFY14, and the lower-end of its guidance otherwise), along with expansion in margins. We have factored in the lower end of the management’s guidance, with a 100bps expansion in margins, which we think is reasonable (as explained above). Rupee fall is an upside risk to our estimates.
Valuation: 4Q has historically been a very strong quarter for DLL and we expect the stock to rebound in the near term, given its steeply discounted valuation of 16xFY14E EPS. Further, with major capex activity nearing its end, we expect strong free cash flow generation over the next two years (Rs4.9bn versus Rs4.9bn over the past five years), which coupled with strong earnings growth (27% earnings growth likely in FY14E) and expansion in RoE/RoCE by 160bps/220bps, respectively, will support valuation. We have retained our Buy rating on DLL with a target price of Rs1, 276.