Lanco Infratech (down to Neutral; 12-m TP: Rs71) Goldman Sachs

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Lanco Infratech (LAIN.BO, down to Neutral; 12-m TP: Rs71)
Source of opportunity
 We downgrade Lanco Infratech to Neutral from Buy and lower our
12-month target price to Rs71 (from Rs81). Since we added Lanco
Infratech to the Buy list on November 5, 2009, the stock increased by
28% (vs. BSE Sensex up 25.5%). The stock outperformed the BSE
Power Index by 19.8% over the same time frame. Over the past 12
months, the stock has increased 30% (vs. BSE Sensex up 20%).
 We believe the current market price already reflects most of the
certainty in near-term projects overlooking the potential risks
associated with 4GW projects that are scheduled for commissioning
only in FY14.
 Lanco’s Babandh, Amarkantak III, and Vidharbha projects constitute
about 30% of the total value of the power business. About 50% of
offtake for Vidharbha, 70% for Amarkantak III, and 75% for Babandh
is still to be tied up for long-term PPA mechanism. We believe these
capacities are most exposed to competition and as a result we have
assumed a tariff level of Rs3/unit for these capacities.
 Kondapalli III capacity is still open and there is some uncertainty on
the availability of the gas and its pricing. We believe the market
price is still not reflecting the offtake risk associated with the
Kondapalli III, Babandh, Amarkantak III and Vidharbha.
 Lanco is most exposed to domestic fuel availability risk as 74% of its
capacity based on domestic-linkage coal operates on non-fuel pass
through mechanism. Lanco is highly leveraged compared with its
peers (2.5X net debt to equity vs. 1.5X for its peers); we believe it has
limited ability to control its fuel costs by integrating backwards in
terms of acquiring overseas coal mines.
 We could turn constructive on the stock if Lanco manages to tie up its
capacities at PPA rates above our estimates and provides more visibility
on its long-term growth plans beyond the current 9.3GW in its portfolio.
Valuation
We revise FY11E/FY12E/FY13E EPS by 1%/-6%/-11% to reflect the impact of
accelerated depreciation for some of its projects and lower merchant
prices. Our revised 12-m SOTP-based TP of Rs71 (from Rs81 as we roll over
to FY12E and revise our merchant power assumptions) implies potential
upside of 7%. The stock appears fairly valued on FY12E P/E and P/B vs. ROE
multiples and has muted CROCI returns compared with its peers (Exhibit
20, 21 & 24).
Key risks
(1) Delays in projects under construction; 2) higher-than-estimated
decline in short-term rates; and 3) tying up of power capacities at
attractive PPA rates