Cairn Energy PLC (LON: CNE) – Strengthened financial flexibility and reduced the risk profile

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 20 January 2021, CNE expects to report pre-close trading update. Further, it will announce the full-year report and results on 9 March 2021.

(Source: Company Website)

Growth Prospects and Risk Assessment

Cairn Energy has proposed a special dividend per share of 32 pence, equating to a return of nearly US$250 million to shareholders. This special dividend was announced following the sale completion of Senegal interests. CNE has delivered transformational value for over 20 years. Cairn has acted as an operator and partner in all stages of oil and gas lifecycle. It has demonstrated the ability to overcome any operating challenges across offshore and onshore, in frontier and remote areas, in deep water and shallow locations. Moreover, it is expanding operations to Senegal, Norway, and Mexico, which is expected to generate good production volumes for the Company. During H1 FY20, average net oil production fell at the top end of the full-year guidance at ~22,400 bopd (barrels of oil per day) while the strong cash position was maintained without drawing any debt. In FY20, CNE expects to deliver production of 21,000 - 23,000 bopd at average production cost ~US$18/boe.

However, there are certain risks and uncertainties to business growth. The fluctuation in oil prices can impact the financial position. Also, the lack of exploration and appraisal success can lead to failure of the balanced business model. Moreover, insufficient capital to pursue business opportunities and manage operations can create funding issues. Furthermore, the failure to secure new venture opportunities can affect the ability to sustain production levels. Also, the lack of adherence to safety, environment, and health policies can lead to regulatory penalties and clean-up costs. It is also exposed to oil & gas prices fluctuation and political & fiscal instabilities. 

Industry Outlook Dynamics

According to the Grand View Research, the market size for global energy as a service is expected to reach US$172.9 billion by 2027, representing a CAGR of 14.6% from 2019 to 2027. The future demand for energy consumption is likely to be influenced 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. Moreover, the oil industry is the most vital branch of the world economy as more than four metric tons of oil is produced globally on an annual basis. Nearly one-third is contributed by the Middle East Region.

Furthermore, oil prices topped 11-month high on 12 January 2021 with output cut pledged by the Saudi Arabia, which can keep the oil industry buoyant amid the subdued demand for energy.

After understanding the industry dynamics, we will analyse some key fundamental and shareholders statistics of Cairn Energy Plc.

Recent Developments

On 11 January 2021: The Company stated that the New Ordinary Shares in the Company (following Shareholder approval of the Return of Cash on 8 January 2021) was admitted to the Official List and maintained by the Financial Conduct Authority. While it commenced trading on the Main Market of the LSE (London Stock Exchange) on the above same date. Therefore, the total number of issued shares and voting rights is 499,075,775, with no treasury shares.

On 7 January 2021: Cairn Energy stated that it had proposed a special dividend of 32 pence per eligible ordinary share on 17 December 2020, which also amounts to a return of around USD 250 million to shareholders. It also made a Share Consolidation, which will be 11 New Ordinary Shares for every 13 Existing Ordinary Shares. So, its nominal value will be 21/13 pence per New Ordinary Share. However, the consolidation process will reduce the number of the Company's issued ordinary shares.

Financial and Operational Highlights (for the six months ended 30 June 2020 (H1 FY20), as on 29 September 2020)

(Source: Company Website)

• Revenue from hydrocarbon sales decreased to USD 172.1 million against the same period last year, driven by the decrease in the oil price during the period. The fall in oil price was mainly due to oversupply from the “OPEC plus” group of producers combined with demand destruction resulting from the COVID-19 pandemic.
• In Catcher and Kraken, the production levels have continued to be strong in H1 FY20, with a combined production for H1 FY20 of average ~22,900 boepd (before adjusting for FlowStream entitlement).
• In H1 FY20, the average gross production from Kraken area fields was ~ 39,000 bopd.
• Catcher remains on the plateau, and cumulative production to 30 June was over 47 mmbbls, with an average gross production of approximately 54,500 bopd.
• The Company witnessed a healthy production from the UK assets, with cash inflows from oil and gas production of USD 132 million.
• Cairn has also shown a strong net cash position, and limited capital commitments, with no drawn debt and Group’s cash of USD 84 million stood at 30 June 2020.
• The Company saw an impairment charge of ~USD 240 million, with USD 33 million against UK producing assets and USD 207 million against Senegal assets.
• In Mexico, the Company completed its 2020 drilling programme.
• It is continuously expanding the product portfolio and penetrating new markets.
• Senegal's sale decision has positioned the Company for growth, and towards portfolio expansion as post the completion of the project, it would receive USD 300 million and reimbursement of the capital expenditure for 2020.
• It has endorsed the World Bank Zero Routine Flaring (ZRF) by 2030 initiative.
• CNE is planning to declare a special dividend of USD 250 million to shareholders following Senegal Interests' sale.
• Further, USD 135 million of capital expenditure is planned for FY20.
• In FY20, the CNE expects to produce 21,000 - 23,000 bopd at an average production cost of ~USD 18/boe.
• It also expects Senegal based Sangomar field to target first oil in 2023 with 100,000 bopd of gross production.

Financial Ratios

Share Price Performance Analysis

(Source: Refinitiv, chart created by Kalkine Group)

On 13 January 2021, at the time of writing (before the market close, at 9:15 AM GMT), Cairn Energy PLC’s shares were trading at GBX 197.68, down by 0.66% against the previous day closing price. Stock 52-week High was GBX 239.70 and Low of GBX 57.28, respectively.

From the technical standpoint, the shares were trading above the short-term support level of 20-day SMA (GBX 190.71), and 20-day EMA (GBX 193.66) simple moving average price.

In the last six months, Cairn Energy share price has delivered ~58.38% return as compared to the ~19.14% return of FTSE 250 index, and a ~12.39% return of FTSE All Share Resources index, which shows that the stock has outperformed the benchmark index and sector during the last six months.

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

Business Outlook Scenario

In the year ahead, CNE looks forward to exploring opportunities in a drilling programme in offshore Mexico, while progressing well in offshore Senegal operations. The Company expects Senegal based Sangomar field to target first oil in the year 2023 with 100,000 bopd of gross production. Moreover, it 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 it 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 FY20, the CNE expects to produce 21,000 - 23,000 bopd at an average production cost of ~US$18/boe. Further, US$135 million of capital expenditure is planned for FY20, which includes US$95 million for Exploration & Appraisal and US$40 million for Development & Production (excluding Senegal). In a nutshell, Cairn is well-positioned to capture further growth opportunities and return attractive value to shareholders.

  (Source: Company Presentation)

Considering the decent operating & financial performance, high level of cash generation capabilities, sustainable business model, and support from the valuation as done using the above method, we have given a “Buy” recommendation on Cairn Energy at the current price of GBX 197.68 (as on 13 January 2021, before the market close at 9:15 AM GMT), with lower-double digit upside potential based on 6.80x 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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