Lanco Infratech valuation by Citi

Lanco Infratech
(LAIN.BO; Rs69.90; 1M)
Valuation
Traditional valuation methodologies like P/E and EV/EBITDA multiples can be
misleading if used to value pure infrastructure asset holders, as project
profitability can be lumpy, given the year of commissioning and life of the
asset. Infrastructure assets, especially electric utilities, generate regular and
largely predictable cash flow streams for a fixed period. Therefore, discounted
cash flow (DCF) is best suited.
While applying the DCF one can either choose free cash flow to the firm (FCF)
or free cash flow to equity (FCFE). We prefer FCFE as individual projects are
highly geared and gearing changes as debt is rapidly paid off.
We value Lanco Infratech at Rs80/share with EPC at Rs23/share (11x Dec-11
EPS - 20% discount to mid-cap construction), Power at Rs56.8/share (DCF on
FCFE using 13% CoE), Roads at Rs2/share (DCF on FCFE using 13% CoE) and
other businesses at Rs(-1.6)/share.
Risks
Our quantitative risk-rating system, which tracks 260-day historical share price
volatility, assigns a High Risk rating to Lanco Infratech. However, we believe a
Medium Risk rating is more appropriate given the status of projects under
implementation, industry-specific risks, financial risk and management risks.
LANCI's Medium Risk rating is more appropriate as: 1) its 6,000MW of capacity
under implementation, has fuel, land, off-take arrangement and bulk of
financing tied up; 2) The construction on a large part of this capacity is in
advanced stage; 3)The power portfolio has ~80% of capacity operating on full/
fuel cost pass-through mechanism. These factors, we believe, reduce risk
substantially.
Given that LANCI is a play on both execution and operation of power plants,
execution delays would have a bigger impact on numbers and company value.
Other downside risks that could prevent the stock from reaching our target
price include financial closure delays, fuel supply disruption, equipment
quality and lower-than-expected merchant tariffs.