Cairn Energy Looks Attractive To Me

Published in Company Comment on 29 December 2012

Cairn Energy (LSE: CNE) has plenty of cash and trades around book value.

The FTSE 250 share and oil and gas exploration business Cairn Energy (LSE: CNE) has caught my value eye.

Let's get the negative bits out of the way first. It doesn't pay dividends and usually makes an accounting loss. Clearly then it's not a P/E or yield play. Which when deducted from my four basic value filters leaves us with assets and net debt/cash to consider and this is where I think it scores.

The current market cap with the shares at 261p is £1,572m. The latest accounts are for the half year to 30 June and are in US dollars like all oil and mining businesses because their commodities are traded in this currency.

The accounts tell me that net assets were $3,493.6m which includes net cash of $926.8m and note that this net cash is almost wholly the value nirvana of pure net cash. In fact it is gross cash of $932.8m less a very small borrowing of $6.0m.

The net assets include also a stake in Cairn India Ltd (CIL) which the firm considers as available for sale. CIL is quoted on the Indian stock market and the valuation was $1,932.5m so this can be seen as a near cash asset.

With intangibles of $643.1m, deducting this from net assets makes net tangible assets of $2,850.5m at 30 June. Using the current exchange rate of £1.61/$ gives a sterling equivalent of £1,770m, a little above the current cap.

But that's not the end of the story because there have been some major post balance sheet developments. Since then it has received about $1,300m from the sales of further tranches of CIL and spent $558m on acquiring Nautical Petroleum.

Some other acquisitions were made and by 30 September, according to the latest news given in the interim management statement of that date, it had $1,600m in cash and still retained about a 10% holding in CIL worth some $1,200m. Since Cairn regards the CIL stake as saleable, this means cash and near cash of $2,800m, equivalent to about £1,739m and above the whole current market cap of the group.

In the first half of this year, a substantial cash payment totalling some $3,500m was made to shareholders following an earlier sale of a chunk of the CIL holding, following which a consolidation of the share capital was effected. I'm not saying this will be repeated though because Cairn says that it regards this cash as being required for exploration expenditure and new business opportunities.

But I do observe that Cairn has been able to generate cash in a substantial way and if that continues, it is likely to have some beneficial effect on the share price. I am though naturally a little wary of such things because a lot of what some people perceive as management skill is often down to just luck.

Additional points in Cairn's favour are that it's not a small cap. My view is that where other things are more or less equal, a bigger share is better than a smaller one for a value investment. They tend to be less risky because size matters.

The sizeable cap has the further advantage that the spread is very low. As I write it's quoted at 260.5/260.8p bid/offer which is inconsequential. Smaller caps will usually have very large spreads in comparison and this matters because the larger the spread, the greater the percentage price rise required to score a profit. 

Also, Cairn's mineral assets are largely in politically stable areas. It says that it is currently focused on the Atlantic Margin, including Greenland and Morocco along with the Mediterranean so it's less likely to fall foul of nasty stuff such as revolutions, wars, corruption and the like thereby offering somewhat lower risk than those exploration companies which do operate principally in potentially troublesome regions.

However, do be aware that mining and oil exploration businesses are inevitably much higher risk, even as value plays, than dull widget makers or example. One reason is that they depend upon the often volatile price of their mineral on the commodity markets, with the result that profits and asset values can fluctuate alarmingly and easily render them unviable with a big enough price drop.

Another is that the very nature of the business, quite apart from fluctuating prices, is risky in that punts can be taken on a potential field and come up dry or find that it's not commercially viable even if the stuff is present. The gusher or mother lode of folk tales is all too chimeric in real life and history is littered with failed such ventures.

Yet another risk is that because Cairn accounts in US dollars, there is exchange rate fluctuation for sterling holders which can affect the valuation of profits and assets, and hence the value criteria.

But if you fancy a value play on this sort of business, Cairn looks attractive to me. I suggest that it's not one for farmers though because of the risks, the lack of dividends and lack of normal trading profits.

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tournesol2 03 Jan 2013 , 10:15am

What a disappointing article.

It strikes me a simply absurd and misleading to classify Cairn or any other E&P as a value play. Categorising an integrated oil major as value is a pretty adventurous step, but a smaller, upstream oriented E&P? Makes no sense at all.

The traditional metrics used in identifying/analysing value stocks simply don't work in the E&P sector. P/E ratios, booked asset value and so on are simply meaningless. The only asset value that has any meaning at all is the value of reserves. And for exploration activity the expected value of reserves that have yet to be discovered - ie the value of the reserves which are statistically likely to be found taking into account all the uncertainties along the way.

The OP is particularly misguided in attributing an overwhelming importance to political risk as distinct from geological and regualtory risk. Which asset is worth the most - an exploration prospect offshore Ghana/Nigeria in promising geology? Or a prospect in Luxemburg with unpromising geology? It's not really a sensible question is it?

PYAD is infamous for dismissing SOCO as a tin pot company operating in tin pot places - and thereby missing a 70 bagger. i have to say that his endorsement of Cairn does not strike me as evidence that he has finally got his head around the sector.

moderated 03 Jan 2013 , 10:48am

The author says:
"Cairn's mineral assets are largely in politically stable areas. It says that it is currently focused on the Atlantic Margin, including Greenland and Morocco along with the Mediterranean so it's less likely to fall foul of nasty stuff such as revolutions, wars, corruption and the like"

That might well be their current focus of exploration, but I don't think they have found a single drop of commercial oil there? So it is complete rubbish to suggest that is where their assets actually are.

I'm constrained by the need to be polite, so I'll just stop at pointing out that this article appears to be complete rubbish, written by someone who doesn't understand oil company accounts (otherwise he'd have commented about capitalised exploration costs).

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