Should you buy Cairn India?

On Monday, while Cairn India gained 2%, or Rs 3.5 to Rs 185 levels on the NSE at 11:10am, Vedanta was trading 0.4% lower at Rs 183 levels

Anil Agarwal controlled Vedanta Ltd announced plans of merging Cairn India with itself on Sunday. Subject to regulatory approvals, the transaction is intended to be completed by the first quarter of 2016. Shareholders in Cairn India would be offered an equity share of Vedanta Ltd, besides a 7.5% redeemable preference share of Rs 10 face value.

While the Street was expecting the merger announcement, analysts were positively surprised by the issuance of one redeemable preference share.

Vedanta has indicated that there are multiple benefits for Cairn India with this merger such as earnings de-risked through diversification, stable cash flows supporting investment & dividends through the cycle, exposure to well invested Tier-1 metals and mining assets.

On Monday, while Cairn India gained 2%, or Rs 3.5 to Rs 185 levels on the National Stock Exchange (NSE) at 11:10am, Vedanta was trading 0.4% lower at Rs 183 levels. By comparison, the CNX Nifty was trading at 8,023 levels, up 0.5% or 40 points.

STOCK STRATEGY

Given these developments, should you buy Cairn India?

Analysts at Kotak Securities believe that most of the negatives for Cairn India are already priced in and have upgraded their recommendation to ‘Accumulate’ with a revised price target of Rs 199. They believe the stock price movement of Cairn India, going ahead, will reflect on the stock price movement of Vedanta, once all approvals are received.

“We believe at current price, stock is reasonable valued at 2.5x EV/EBIDTA and 8.3x P/E based on FY17E earnings estimates. We arrive at the fair value of the stock is Rs 199/share. The recent fall in the stock price discounts most of the negatives,” said Sumit Pokharna an analyst tracking the company with Kotak Securities.



The management indicated that the liability of the tax demand of Rs 20,500 crore on Cairn India would not be on Vedanta. Cairn India received a tax demand for failure to deduct withholding tax on alleged capital gains from its former promoter Cairn Plc. In case of an unfavourable verdict, analysts say Vedanta will have legal recourse to recover the tax liability from Cairn Plc.

Vedanta Ltd, according to reports, has a gross debt of Rs 77,752 crore at the end of FY15, with Rs 38,480 crore of debt at standalone entity and Rs 27,145 crore of debt in Cairn acquisition SPV. In FY16, the company has scheduled debt repayments of $1.9 billion and a capex of $1 billion.



“The merger is a positive for Vedanta shareholders as this would provide access to Cairn’s cash and continuing free cash flow generated by Cairn. The merger would also eliminate the holding company discount and hence Cairn’s full valuations would be reflected in Vedanta’s valuations. Cairn’s stock price movement hereon would be in-line with Vedanta’s stock performance. We maintain our ‘Accumulate’ rating on the stock with a revised price target of Rs 210,” points out a note from IIFL.

Analysts tracking the company with Motilal Oswal suggest that the merger is a win-win for the shareholders of both Vedanta and Cairn. Vedanta has quality assets of zinc, lead, silver, copper TCRC, aluminium, oil, iron ore and power spread across India and also owns small copper mines in Australia and zinc lead assets in Africa and Lisheen.

"Cairn shareholders will now get additional exposure to low cost high quality diversified set of metals and power business thereby reducing the risk to single commodity. The merger will also help in optimising the capital structure of group and reducing cost of funding. Our sum-of-the-parts target price (SOTP) of Rs 209 for Vedanta factors metal prices (FY17E Aluminium of $2000/t, Zinc $2200/t and crude oil of $70/bbl). If we were to value on spot commodity prices, our SOTP would fall to Rs 163. We maintain Neutral rating on the stock, in view of weak commodity prices," they add.