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Lanco Infratech - Quantum leap in execution, Buy
„In a sweet spot; Buy
We rate Lanco Infratech as Buy due to (a) 4.4x growth in power capacity, funded
and under construction (b) profitable sales volume mix (¾ long-term, amongst top
3 player in short-term) driving RoE to 19% by FY13E (c) can recover fuel cost
inflation in two-thirds of FY13E capacity. Accelerated depreciation would dampen
earnings CAGR at 35% in FY10-13E but CFO would grow to Rs70bn in FY13E
(vs Rs1.6bn in FY10). We cut EPS by 43% during transitioning coverage on lower
volume, higher depreciation and capacity slippage. Buy on high growth, ST play,
inflation pass-through with PO Rs74 (37% potential upside).
Power: 2.25x jump by FY13E, further 2x by F15E
We view Lanco as well positioned for accelerated jump in power portfolio over 4-5
years. Capacity is estimated to increase from 2.1GW (9MFY11) to 4.7GW by
FY13E (a 2.25x jump) and to 9.2GW by FY15E, largely coal based. This capacity
has completed most of the development milestone, achieved financial
closure/debt tie-ups (Rs230bn+ in FY11E - an historic high and amongst the
highest in the sector) and is under construction. More importantly, three-quarters
of volume being sold on a long-term basis in FY13E (from ½ in FY11E) would
provide revenue stability.
Earnings growth, ROE/ROCE and balance sheet
Our below-consensus outlook expects earnings CAGR of 35% in FY10-13E on (1)
76% volume CAGR, (2) short-term tariffs of Rs4.5 and Rs3.5/unit in FY12-13E, (3)
fuel cost pass-through for 66% of capacity, (4) a favorable depreciation policy at
15%, and (5) a strong E&C book. ROE would rise to 19% but ROCE will remain
below 10%. Net debt:equity at 4x by FY13E is due to capacity expansion.
SoTP based PO, risks
Our SoTP gives a PO of Rs74/sh based on a combination of DCF and exit P/BV
and P/E (power Rs52/sh, EPC Rs22/sh). Downside risks are a significant fall in
merchant prices, regulatory risk, an interest rate rise, significant delays in capacity
additions and worsening SEB financials
Valuation
We reiterate our Buy rating on Lanco Infratech with a price objective of Rs74. We
have used a sum-of-the-parts (SOTP) approach, since Lanco has interests in
power, construction, roads, mining and realty. Our SOTP is based on DCF via
which we value each infrastructure asset. Earnings multiple-based methodology
has been used for the construction division at an exit multiple in line with Indian
peers. Further, book value multiples are used for regulated power generation
assets wherein Lanco enjoys assured ROE. A conglomerate discount of 10% is
used given the significant interdependence of the construction and power division
for the cash flows.
Our SOTP approach…
Only projects meeting stringent criteria & with all clearances included
We have applied stringent criteria for incorporating the value of assets wherein
financial closure/debt tie-ups have been achieved, statutory approvals like
environmental/forest clearance obtained, equipment ordering is complete and fuel is
secured. For instance, in the power portfolio, we have valued about 5.3GW (from a
pipeline of 9.2GW) individually as these projects have completed development
milestones and are either operating or at advanced stages of construction. Both the
road assets are under construction and are thus valued separately.
Varying costs of equity to reflect risk-return profile
We have used varying costs of equity (COE) for each asset to reflect the inherent
risk-return profiles, and execution, operating risks. Accordingly, for operational
assets, we use COE of 12.5% while for assets under construction, COEs of 13.5-
15% are used.
…yields a PO of Rs74 (37% implied upside)
Our SOTP-based methodology yields a value of Rs78/share (after a
conglomerate discount of 10%). This comprises:
1. Power assets - operating as well as construction - Rs52/share (70%) valued
using DCF with varying COE 12.5-15% and exit P/B of 1.5x FY12 for
regulated assets.
2. EPC business - Rs22/share (29%) valued using exit P/E of 12x FY12E - in
line with other mid-cap construction companies.
3. The balance of Rs9/sh comprises road BOT projects, power trading, realty
and cash at book value.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Lanco Infratech - Quantum leap in execution, Buy
„In a sweet spot; Buy
We rate Lanco Infratech as Buy due to (a) 4.4x growth in power capacity, funded
and under construction (b) profitable sales volume mix (¾ long-term, amongst top
3 player in short-term) driving RoE to 19% by FY13E (c) can recover fuel cost
inflation in two-thirds of FY13E capacity. Accelerated depreciation would dampen
earnings CAGR at 35% in FY10-13E but CFO would grow to Rs70bn in FY13E
(vs Rs1.6bn in FY10). We cut EPS by 43% during transitioning coverage on lower
volume, higher depreciation and capacity slippage. Buy on high growth, ST play,
inflation pass-through with PO Rs74 (37% potential upside).
Power: 2.25x jump by FY13E, further 2x by F15E
We view Lanco as well positioned for accelerated jump in power portfolio over 4-5
years. Capacity is estimated to increase from 2.1GW (9MFY11) to 4.7GW by
FY13E (a 2.25x jump) and to 9.2GW by FY15E, largely coal based. This capacity
has completed most of the development milestone, achieved financial
closure/debt tie-ups (Rs230bn+ in FY11E - an historic high and amongst the
highest in the sector) and is under construction. More importantly, three-quarters
of volume being sold on a long-term basis in FY13E (from ½ in FY11E) would
provide revenue stability.
Earnings growth, ROE/ROCE and balance sheet
Our below-consensus outlook expects earnings CAGR of 35% in FY10-13E on (1)
76% volume CAGR, (2) short-term tariffs of Rs4.5 and Rs3.5/unit in FY12-13E, (3)
fuel cost pass-through for 66% of capacity, (4) a favorable depreciation policy at
15%, and (5) a strong E&C book. ROE would rise to 19% but ROCE will remain
below 10%. Net debt:equity at 4x by FY13E is due to capacity expansion.
SoTP based PO, risks
Our SoTP gives a PO of Rs74/sh based on a combination of DCF and exit P/BV
and P/E (power Rs52/sh, EPC Rs22/sh). Downside risks are a significant fall in
merchant prices, regulatory risk, an interest rate rise, significant delays in capacity
additions and worsening SEB financials
Valuation
We reiterate our Buy rating on Lanco Infratech with a price objective of Rs74. We
have used a sum-of-the-parts (SOTP) approach, since Lanco has interests in
power, construction, roads, mining and realty. Our SOTP is based on DCF via
which we value each infrastructure asset. Earnings multiple-based methodology
has been used for the construction division at an exit multiple in line with Indian
peers. Further, book value multiples are used for regulated power generation
assets wherein Lanco enjoys assured ROE. A conglomerate discount of 10% is
used given the significant interdependence of the construction and power division
for the cash flows.
Our SOTP approach…
Only projects meeting stringent criteria & with all clearances included
We have applied stringent criteria for incorporating the value of assets wherein
financial closure/debt tie-ups have been achieved, statutory approvals like
environmental/forest clearance obtained, equipment ordering is complete and fuel is
secured. For instance, in the power portfolio, we have valued about 5.3GW (from a
pipeline of 9.2GW) individually as these projects have completed development
milestones and are either operating or at advanced stages of construction. Both the
road assets are under construction and are thus valued separately.
Varying costs of equity to reflect risk-return profile
We have used varying costs of equity (COE) for each asset to reflect the inherent
risk-return profiles, and execution, operating risks. Accordingly, for operational
assets, we use COE of 12.5% while for assets under construction, COEs of 13.5-
15% are used.
…yields a PO of Rs74 (37% implied upside)
Our SOTP-based methodology yields a value of Rs78/share (after a
conglomerate discount of 10%). This comprises:
1. Power assets - operating as well as construction - Rs52/share (70%) valued
using DCF with varying COE 12.5-15% and exit P/B of 1.5x FY12 for
regulated assets.
2. EPC business - Rs22/share (29%) valued using exit P/E of 12x FY12E - in
line with other mid-cap construction companies.
3. The balance of Rs9/sh comprises road BOT projects, power trading, realty
and cash at book value.
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