Cairn Energy PLC (LON: CNE) – Selling Sangomar assets to Woodside Petroleum

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 29 September 2020, the Company is expected to release the half-yearly results for FY20.

(Source: Presentation, Company Website)

Key Fundamental Statistics

Industry Outlook Dynamics

As per Grand View Research, the market size for global energy as a service was valued at around US$58.04 billion in 2019, and it is expected to grow at a CAGR of 14.6% from 2019 to 2027. 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 boost the energy demand for economic activities.

(Source: Presentation, Company Website)

Growth Prospects and Risk Assessment

CNE is an oil industry pioneer, which has delivered transformational value for more than 20 years. It has explored, discovered, developed, and produced oil and gas in various locations around the world. It has acted as an operator and partner in all stages of oil and gas lifecycle. CNE has demonstrated the ability to overcome any operating challenges across offshore and onshore, in frontier and remote areas, in deep water and shallow locations. The Company’s financial strength lies in the funding flexibility, which underpins the core element for future growth and strategic delivery. Moreover, it is expanding operations to Senegal, Norway, and Mexico, which is expected to generate good production volumes for the Company. Meanwhile, the disposal of Norwegian business coupled with exits from Ireland and Nicaragua’s exploration position demonstrates the Company’s focus on capital allocation.

(Source: Kalkine Research, Refinitiv)

However, there are certain risk and uncertainties to business growth. The failure to replenish the portfolio can impact the ability to sustain production levels and replace reserves. The lack of adherence to the environment, safety, health, and security policies can damage the reputation and bring regulatory penalties. Moreover, failure to replenish the portfolio can impact the ability to sustain production levels and replace reserves. Also, the misalignment of joint ventures can put a negative impact on asset value and can cost schedule overruns.

Key Shareholders Statistics

Recent Developments

7 September 2020: CNE agreed to sell the entire interest in RSSD (Rufisque Offshore, Sangomar Offshore and Sangomar Deep Offshore) to Woodside. The new deal replaces the US$400 million transaction agreed with Lukoil.

17 August 2020: The Company proposed a sale of interests in the Sangomar field offshore Senegal to Lukoil.

27 July 2020: The Company entered an agreement to sell entire 40% interest in the Sangomar Offshore, Rufisque Offshore, and Sangomar Deep Offshore Contract Area to LUKOIL, for a cash consideration of up to US$400 million. Following the transaction completion, the Group intends to return at least US$250 million to shareholders.

(Source: Presentation, Company Website) 

A Glimpse of Business Segments

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

(Source: Annual Report, Company Website)

Operational Update (released on 27 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 Company 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.
• CNE remained well-funded from existing sources, with opening cash position in 2020 of USD 255 million and Undrawn reserves-based lending facility of USD 575 million.

Financial Highlights – FY2019 (31 December 2019)

(Source: Annual Report, Company Website) 

• For the financial year 2019, daily production volume from Catcher and Kraken increased to around 67,200 boepd and 35,600 bopd, respectively.
• Driven by an increase in oil sales and production volumes, the revenue increased by around 30% to USD 533.4 million.
• The profitability margins improved significantly for the period, with a cash balance of USD 146.5 million as on 31 December 2019.
• The Company has a well-positioned balance sheet for the period, while the net debt increased to USD 90.8 million as on 31 December 2019 (31 December 2018: USD 76.9 million).
• The net cash inflow from the production of oil and gas stood at USD 390 million in FY2019 with capital expenditure of USD 242 million.

Financial Ratios – Strong Profitability Margins versus the Industry Median

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. Cairn Energy Plc has delivered a decent return for the shareholders’ as Return on equity of 8.4% was lower as compared to the industry median of 9.2%. On the liquidity front, Cairn Energy Plc’s current ratio was higher than the industry median of 1.28x, 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 0.47x, reflecting that the company is less leveraged as compared to the industry.  

Share Price Performance Analysis

Daily Chart as on 16 September 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On 16 September 2020 (before the market close, at 8:39 AM GMT+1), Cairn Energy Plc shares were trading at GBX 134.70, down by 1.46% against the previous day closing price. Stock 52-week High was GBX 216.80 and Low of GBX 57.35, respectively.

From the technical standpoint, shares were trading well above the short-term support level of 50-day (GBX 134.00) and 100-day (GBX 126.60) simple moving average prices, which reflects an uptrend in the stock.

14-day RSI is currently supporting the upward movement (39 level), which means there is a good potential for a short term rebound in the stock price.

Cairn Energy Plc Vs FTSE-250 Index (6 months)

(Source: Refinitiv, Thomson Reuters)

In the last six months, Cairn Energy Plc share price has delivered 99.94 per cent return as compared to 23.91 per cent return of FTSE-250 index, which shows that the stock has outperformed the index during the last six months.

Valuation Methodology: Price/Cash Flow Approach (NTM) (Illustrative)

Business Outlook Scenario

The Company has a low breakeven production, strong balance sheet, and limited capital commitments, which provides enhanced financial flexibility to invest in and grow the business, while the Group is committed to returning excess cash to shareholders. For example, from the disposal proceeds of Senegal interests, it intends to return at least US$250 million to shareholders. In the year ahead, the Company looks forward to exploring opportunities in a drilling programme in offshore Mexico, while progressing well in offshore Senegal operations.

In the financial year 2020, CNE expects capital expenditure to be around USD 615 million. The Company plan’s two further non-operated exploration wells in Mexico. The Group expects Senegal based Sangomar field to targeting first oil in year 2023 with 100,000 bopd of gross production. It is continuously expanding the product portfolio and penetrating new markets. It is planning to declare a special dividend to shareholders following the sale of Senegal Interests.

 (Source: Presentation, Company Website) 

Considering the improved production, increased financial performance and support from the valuation as done using the above method, we have given a “Buy” recommendation on Cairn Energy Plc at the current price of GBX 134.70 (as on 16 September 2020, before the market close at 8:39 AM GMT+1), with lower-double-digit upside potential based on 5.27x Price/NTM Cash Flow (approx.) on FY20E cash flow per share (approx.). 

*Dividend Yield may vary as per the stock price movement.

*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.

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