Cairn Energy sell-off overdone

With no income to offset spending, Cairn Energy's losses were always going to be big. But it has at least managed to halve the deficit and industry expert Malcolm Graham-Wood thinks the shares could be undervalued, especially with the oil company's pipeline of exciting assets.

Although it's a big number, a pre-tax loss of $559 million is a lot smaller than the $1.1 billion reported in 2013. Unfortunately, this figure will not improve much until Cairn is pumping oil out of the ground. But the firm had a good year operationally, discovering oil in its exploration programme offshore Senegal - one well is potentially the biggest global discovery of the year. The group is planning to drill six more in the region over the next nine months.

The oil group also successfully participated in the UK and Norwegian licencing rounds, completed farm-in and -downs and accelerated the financing of its development projects. It's collected impressive data on how much oil it reckons is in the ground in the North Sea and Senegal, and progression in its Catcher and Kraken developments offshore UK has kept it on track for free cash flow generation in 2017. At 31 December, Cairn had booked 2P reserves at 56.1 million barrels of oil equivalent, and 171.6 mmboe of 2C contingent resources.

"The future cash flows from these projects will support a self-funding, sustainable business model over the medium and long term," chief executive Simon Thomson said in a statement.

"From 2017, we anticipate free cash flow from these assets with a production estimate of around 22,500 barrels of oil equivalent per day net to Cairn. We keep a disciplined focus on projects right across our portfolio to ensure they deliver strong returns even in a lower oil price environment and our North Sea development investments are in line with that strategy."

Although Cairn's cash pot has taken a hit and is a third lighter at $869 million, it's still in a strong position. Coupled with an undrawn $575 million debt facility, its $185 million exploration plan and $590 million capex budget are fully funded until its North Sea assets start earning money. The fall in oil prices should allow Cairn to benefit from lower industry costs.

Malcolm Graham-Wood is upbeat: "Cairn was one of the first on the notepad for the bucket list primarily due to Senegal but also due to the fact that the company is in a strong cash position, its current developments will enable it to take advantage of significantly reduced industry costs and will benefit should oil prices recover in the longer term. As such it remains a favourite and despite the rally from 143p the stock is significantly undervalued."

Operating in the cyclical oil sector, Cairn suffered with the best of the oil companies as prices slid last year. By February it had managed to recover its losses and more, as the pressure on Brent crude eased. But Cairn is still a long way off from the 260p-300p playing field it was operating in during 2013, before news of its dispute with the tax authorities in India broke. Cairn is still unable to access its 10% holding in Cairn India, valued at around $703 million.

After stabilising slightly above $60 a barrel over the last month, Brent Crude has taken a bit of a nose dive over the last couple of days and is down by over 1% to $57.85 a barrel. Cairn's share price had lost 7% of its value on Tuesday, falling to 185p.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.