Cairn Energy is a "buy"

Shares in Cairn Energy have plunged by a fifth since the Indian Income Tax Department made a $1.6 billion tax claim against the oil company three weeks ago. But UBS now thinks the India issue has been priced-out and that a follow-on drilling campaign offshore Senegal "is the most compelling exploration story in the sector this year".

Cairn is contesting the decision regarding changes to Indian law which seeks to tax prior year transactions under retrospective legislation. The demand relates to capital gains made in 2006 while transferring its India assets to a new company, Cairn India.

"With the stock now trading on a sector multiple ex. the 10% Cairn India stake (72p/share), we see potential option value in the arbitration process," says UBS. The broker also reckons recent discoveries in Senegal have opened a material new oil-prone basin. "We have modelled an indicative field development, benchmarking costs and other parameters against similar West African FPSO [floating production, storage and offloading] projects."

"Economics look more compelling than we'd previously assumed, giving us increased confidence this is not an asset stranded by low prices. The follow-on drilling campaign is the most compelling exploration story in the sector this year."

UBS calculates a $45 per barrel break-even for the remote, deepwater Senegal field. A 20% cost reduction, possible given the easing supply chain, would lower that to $36/barrel.

Upping its stance to 'buy' from 'neutral' with 195p price target - 0.6 times commercial net asset value (NAV) of 324p - the broker argues that Cairn is one of the few exploration and production companies in a position "to counter-cyclically attack the downturn. It should benefit from much lower drilling costs with its 3-6 follow-on wells in Senegal later this year ($30-40m vs. $100m discovery wells)."

"The campaign has potential to significantly add to the resource base and NAV - expect this upside to be showcased at its Capital Markets Day on May 11th. The company is fully funded to deliver its North Sea projects Kraken and Catcher, which come on-stream in 2017E (~20,000 boe/d, net) into what should be a much higher oil price environment."

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.