Cairn Energy was one of the FTSE’s big gainers yesterday. This will come as no shock to anyone who’s been in this game a while as Cairn’s ascent over the years is the stuff of legends.
Investment guru Peter Lynch popularised the term ten-bagger, meaning a stock that is worth - and that has the potential to increase to - ten times its current share price. Cairn Energy didn’t just deliver, it exceeded any investor’s wildest hopes and may be one of the UK’s first fourteen-baggers outside of the penny share market.
From £2.50 in the late 80s, Cairn today trades over £35 and broker notes released yesterday suggest there is even further to go. Swiss bank UBS hiked its recommendation on Cairn to ‘buy' from ‘neutral.’ Also Cairn India’s earnings estimates for this year were tripled as the firm is thought to be better placed to cash in on surging oil prices than local rivals.
£45? Seems a bit toppish... but some clever-clogses are already saying it is not high enough.
"Herein lies the opportunity," as my colleague Garry White at Smart Commodities says. "Oil analysts have a reliable tendency to lag reality meaning that oil earnings will ALWAYS come in ahead of consensus," added Garry who is sitting on a couple of great ways to play the boom. It is this lag that drove gains in the oil majors for quarter-after-quarter-after-quarter. Hence, irrespective of the eye-watering gains — which we will get onto - oil stocks remain a bargain. Analysts’ expectations - which are the basis for their trading plans - are wonderfully out of date so expect oil firms to outperform for a long time to come.
Indian ops are tops
Cairn operates in six continents but right now all eyes are on India.
Cairn’s 65% owned subsidiary Cairn India saw profits paper over the cracks in production for the first three months of 2008. Revenues came in at $79.3m, versus $53.8m in 2007 and the bottom line was markedly higher at $45.8m.
"Our more bullish view is supported by the company's progress regarding the Rajasthan developments," said UBS.
Also, our pet theme of resource nationalisation, where some States push to reduce the control of foreign companies operating in the energy sector, is seemingly not a problem for Cairn. "Most notably, the Indian government has agreed to pay for the export pipeline, and with the contracts for the pipeline's construction now awarded, we have growing faith in a start-up for the Mangala field in the second half of 2009," added the group.
It also helps that in an age where independent bodies are dismayed at the efficiency of R&D projects Cairn’s war chest of net cash stands at $698 million as of 31st March. This means that the firm can freely build on its gross field production of 80,713 for the first quarter.
Cairn Defies Dow’s Law
Let me cool down a bit, this all sounds too good to be true... The share price, the recommendation and the price target for Cairn Energy all defy one’s sensibilities as well as several of the tenets of Dow Theory.
Dow Theory is a century old principle for understanding the movements in and how to intelligently determine direction of the stock market. It is more one for technical analysts and traders than long-term investors, but it is more useful as a means to interpret stock movements than as a buy and sell indicator.
One of the factors of Dow Theory (there are six or seven depending on who you ask) is that markets are supposed to be efficient, i.e. all known facts are reflected in the current price, and fresh news is rapidly incorporated. Trying to reconcile that with a significant price target upgrade is a big ask.
UBS think the price could go to £45 based on their previous target based on cheaper oil. This suggests that there were no opportunists already in the market buying Cairn on the profit prospects based on high prices, which beggars belief.
Dow holds that Cairn should be set for a fall. The primary trend - where the stock is moving in the long-term — goes in three waves. Most technical analysts would contest that we are in that final wave, where all the news is positive and the dumb money is coming into the market just before a big reversal.
This has long been the fear with Cairn.
We are constantly told that if you read about a ‘great opportunity’ in the papers you’ve already missed it. This has kept a lot of nervous investors away from Cairn Energy and those that were invested in it to sell their stakes when it jumped 100%, then 200%, then 300% and so on... The x-factor with Cairn is that it’s not dumb money or speculation driving Cairn, it’s the fundamentals. The price of oil really is that high!
So for investors with an appetite for risk and a thirst for growth — and that’s most investors in the oil sector — there’s still legs in this one.
So is Cairn Energy a buy? It’s a great prospect, but the counter-arguments are equally weighty. Looking for other opportunities in this sector? Let Smart Commodities be your guide through this sector... This strategic investment newsletter focuses on raw materials, energy and infrastructure. Operating in some of the hottest sectors in the market right now ...
Theo Casey
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