Cairn Energy: A tale of continued underperformance

Cairn Energy (LON:CNE), is a UK-based independent oil and gas exploration and production company with a strategy of using its production asset cashflow to fund its exploration and development activity.

Having been listed on the London Stock Exchange for 30 years, those holding its stock know Cairn’s business model means it identifies, explores, appraises, develops, extracts value (of oil or gas), and reinvests in this cycle of activity. 

Value is also extracted through asset sales. Its stated aim is to "maintain a self-funding business model." By that argument, 2018-19 business risks haven’t materially altered year-on-year. They include volatile oil and gas prices; development delays; operational and project performance; reliance on joint venture partners to perform; health and safety, and environmental issues, access to debt markets, and political, regulatory and fiscal uncertainties. 

There is also the issue of Cairn Energy's ability (or otherwise) to secure or repatriate value from Indian assets. A final hearing regarding India’s seizure of the company's assets took place in August but a decision could take months. In H1 alone, India’s tax authority either sold or withheld almost £400m of Cairn assets (shares and dividends). 

As at January 2018, Cairn held 4.9% of the listed shares in Vedanta Limited, its Indian asset, since when 2.7% have been sold by the Indian tax authority. Cairn continues to be restricted from selling its remaining shares in Vedanta and in the meantime is exposed to equity price risk arising from them.

The company says: “Cairn remains confident of its legal position; the Tax Treaty [between the UK and India] affords strong provisions to enforce a successful award." This opinion is reflected in its decision not to make any provision for any of the tax penalties assessed by the Indian tax authority.

Hence, based on its annualised H1 2018 figures and other publicly available information, we summarise the company’s prospects as outlined below:

For: Low gearing (d/e); high tangible net assets (£2.08) per share (market share price, £1.58); strong current ratio (2.75x).

Against:  Poor operational revenue; low interest cover (1.3x); loss after tax (H1: £501 million), so negative EPS and negative RoE; market share price just 47% of book value; high value of goodwill.

Overall: Cairn has turned a £263m 2017 profit into a £501m loss in 2018, both due in part to its continuing spat with the Indian tax authority over unpaid taxes. Its strong capital structure is not matched with revenue and the crucial ability to maintain interest cover.

Oil exploration is by its nature a high risk endeavour. Whilst investment in oil might be a calculated risk, Cairn’s return to shareholders over the recent past has been repeatedly poor. Returns on exploration are unquantifiable, as are the effects of external uncontrollable impacts, including the volatile oil price and political manoeuvres. Overall, equity investors should shun Cairn, which some have obviously already been doing in H2 2018. Those wishing to buy low predicated on risk, however, might feel now is an opportune time to do the exact opposite.