Cairn Energy PLC (LON: CNE) – Emphasizing on Disciplined Capital Allocation and Robust Cash Flow to Weather the Oil Price Slump. 

Cairn Energy PLC is a FTSE 250 listed Oil and Gas Exploration, Development and Production Company. It operates with three business divisions, namely Senegal, UK & Norway, and International. The Senegal operation focuses on appraising the offshore discoveries and explore prospects for further drilling. The UK & Norway division is engaged into exploration activities in the Norwegian Sea, North Sea, and the Barents Sea. It also manages the asset development in the UK. The International operation comprises interest in all other regions where the Company holds exploration licenses, including Mauritania, Ireland, Morocco, Greenland, Western Sahara, and the Mediterranean. The exploration activity of the Group is principally located in frontier and emerging basins.

The Company has been listed on the London Stock Exchange for over 30 years.

On 8^th September 2020, the Company is expected to release the half-yearly results for FY20.

 
(Source: Presentation, Company Website)

Key Fundamental Statistics



Segment Analysis

During 2019, the Company had four reportable operating segments, namely Senegal, UK & Norway, East Atlantic, and LATAM (Latin America). However, the revenue was mainly contributed by the UK & Norway division only.

The breakup of segmental revenue and gross profit for FY19 are as follows:


(Source: Annual Report, Company Website) 

Synopsis of Recent Developments 

7^th May 2020: The Company announced that Ian Tyle, Chairman of the Board, has decided to retire from his position after serving for around seven years on the Board. He will continue to hold the position until the Board appoints a successor, which is expected to take place within the next twelve months.

5^th May 2020: The Company announced the completion of exploration on Block 7 of Eni operated Ehecatl-1, which is located in the Sureste Basin offshore Mexico. The Cairn holds a 30% working interest through the subsidiary, Capricorn Energy Mexico. The purpose of exploration was to prove the availability of hydrocarbons in the Lower Miocene. The well has been permanently abandoned as it did not find any reservoir hydrocarbons.

Operational Key Performing Indicators in 2019

Delivered Exploration Success: In 2019, the Company completed the exploration of six exploration wells and discovered six new prospects for drilling in the period 2020-21.

Progressed Developments: The Company matured SNE field development project to Final Investment Decision in Senegal. Also, it progressed well against key predefined project milestones for the Nova development project.


(Source: Annual Report, Company Website)

Top Shareholders Statistics

 

Update on Drilling Activities in Mexico (as on 5th May 2020)

Cairn Energy released an update on the drilling activities at Mexico. The operations at Block 7 based Ehecatl-1 exploration well has been completed in Sureste Basin Offshore in the Mexican region. The Group has 30 per cent working interest through Capricorn Energy Mexico, a wholly-owned subsidiary. The well has been abandoned and plugged on a permanent basis and does not have any reservoir hydrocarbons.

Operational Update (as on 27th March 2020)

In light of current market conditions, the Company will make substantial reductions and deferrals have already been identified for the 2020 programme, representing an overall 23 per cent reduction in capital expenditure for 2020. The planned capital expenditure for UK producing assets in 2020 is expected to be under USD 45 million, which was reduced from the initial forecast of USD 65 million. The Group has reduced capital expenditure on Sangomar Development Project from the original forecast of USD 400 million to under USD 330 million. The Capital expenditure on exploration activities is now expected to be around USD 100 million versus the original forecast of USD 150 million. The Group’s operations are well funded by the existing sources as well.

Financial Highlights – Reflecting Earnings Growth and Improvements in Margin (31^st December 2019)


(Source: Annual Report, Company Website)
 
For the financial year ending 31st December 2019, driven by an increase in the oil sales for the period, the group’s revenue increased to USD 533.4 million (FY2018: USD 410.3 million). The gross profit stood at USD 243.1 million(FY 2018: USD 107.7 million), reflecting the lower cost of sales for the period. Driven by lower operating expenses for the period, the group reported an operating profit of USD 154.9 million in FY2019 (FY2018: operating loss of USD 129 million). The company’s PBT (profit before tax) from continuing operations stood at USD 119.5 million in FY2019 as against an LBT (loss before tax) from continuing operations of USD 1,211.6 million in FY2018. The profit attributable to the shareholders stood at USD 93.6 million in FY2019 (FY2018: loss of USD 1,135.5 million). The basic earnings per share stood at 16.08 cents in FY2019 (FY 2018: basic loss per share of 195.59 cents).

Financial Ratios – Strong Profitability Margins versus the Industry Median

 
(Source: Refinitiv, Thomson Reuters)

Reported profitability metrics for the financial year 2019 were higher against the industry median, reflecting higher revenue generated and better control over expenses as compared to the industry median. On the liquidity front, Cairn Energy Plc’s current ratio was higher than the industry median of 1.20, reflecting sufficient liquidity to meet short-term obligations. On leverage front, the debt-equity ratio was 0.19x, which was lower as compared to the industry median of 0.49x, reflecting that the company is less leveraged as compared to the industry median.  

Share Price Performance


Daily Chart as on 1^st July 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On July 1, 2020, at the time of writing (before the market close, at 8:42 AM GMT+1), Cairn Energy Plc shares were trading at GBX 119.65, up by 1.57% against the previous day closing price. Stock 52 week High and Low were GBX 216.80 and GBX 57.35, respectively.

Bullish Technical Indicator

From the technical standpoint, 14-day RSI is currently in an oversold zone, which means there is a good potential for a short term rebound in the stock price.

Valuation Methodology

Price/Cash Flow Approach (NTM)



To compare Cairn Energy Plc with peers, Price/Cash Flow multiple has been used. The peers are Pharos Energy Plc (NTM Price/Cash Flow was 8.58), Independent Oil and Gas Plc (NTM Price/Cash Flow was 4.84), Petrofac Ltd (NTM Price/Cash Flow was 4.52), Tullow Oil Plc (NTM Price/Cash Flow was 1.13) and EnQuest Plc(NTM Price/Cash Flow was 0.60). The Average of Price/Cash Flow (NTM) of the company’s peers was 3.93x (approx.)

Cairn Energy Plc Vs FTSE-Mid 250 Index (3 Months)


(Source: Refinitiv, Thomson Reuters)

In the last three months, Cairn Energy Plc share price has delivered 56.30% returns as compared to 18.24% returns of FTSE-250 index, which shows that the stock has outperformed the index during the last three months.

Industry Outlook Dynamics

As per the IBIS World, the market size of global oil & gas exploration and production industry is about USD 3.2 trillion in 2020. It has grown at an average rate of 2.4% per annum over the past five years (between 2015 to 2020). The future demand for energy consumption will be affected by several factors, including change in climate policies and adoption of alternate source of energy. Moreover, 65% of total oil consumption is contributed by transport; hence, it can be impacted by the usage of electric vehicles as well. Contrarily, the rising population and increasing urbanization can surge the energy demand for economic activities.

Growth Prospects and Risk Assessment

The Company delivered a robust operational performance in FY19 and delivered production at the top-end of the guidance. Moreover, a significant milestone was attained in Senegal and Mexico. Meanwhile, the disposal of Norwegian business coupled with exits from Ireland and Nicaragua’s exploration position demonstrates the Company’s focus on capital allocation. Furthermore, the Company is actively involved in reducing carbon emission and targeting to provide sustainable energy from renewable sources as well.

 
(Source: Presentation, Company Website)


However, the Company is exposed to the following principal risks and uncertainties:
 

1. Failure to replenish the portfolio can impact the ability to sustain production levels and replace reserves.

2. Inability to maintain a balanced portfolio can lead to exploration and appraisal failure.

3. Lack of adherence to the environment, safety, health, and security policies can damage the reputation and bring regulatory penalties.

 
Business Outlook Scenario

The Company is able to maintain an adequate capital allocation balancebetween a strong balance sheet, investment for growth and returns to shareholders. It is expanding operations in Senegal, Norway, and Mexico, which is expected to generate good production volumes for the Company. Further, the Group has entered various strategic alliances with the government to expand the operations. The Company has a well-established internal control system, which helps them to mitigate the risks associated with the working of the company. CNE was awarded the 5 licenses in the Offshore Exploration Licence Round in the UK.

In the latest operational update, Cairn showed a good increase in production. Due to the outbreak of coronavirus (COVID-19), the oil prices have fallen substantially in the first quarter of 2020. CNE has shown a good top-line and the bottom-line performance in the financial year 2019. Moreover, the Company’s balance sheet remains strong, and management is proactively reviewing options for additional capital expenditure savings and deferrals, while retaining the financial flexibility to add value on an ongoing basis. The Group expects first oil from Senegal-Sangomar field in the year 2023 with gross production of 100,000 bopd. The operations of Cairn Energy are quite dependent on the global macroeconomic conditions. The Group is continuously expanding the product portfolio and penetrating in new markets. 

Over the course of 2 years (FY17 - FY19), the Company's revenue surged from $33.3 million in FY17 to $533.4 million in FY19. Compounded annual growth rate (CAGR) stood at 300.23 per cent.

Based on the decent growth prospects and support from the valuation as done using the above method, we have given a “BUY” recommendation at the current market price of GBX 119.65 (as on 1^st July 2020, before the market close at 8:42 AM GMT+1), with lower-double digit upside potential based on 3.93x Price/NTM Cash flow (approx.) on FY20E cash flow per share (approx.).
 
 
*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

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