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Lanco Infratech
Overweight
LAIN.BO, LANCI IN
Closer analysis of leverage and funding gap concerns
that have impacted stock performance
• Lanco has sharply underperformed its IPP peers over the last one
month, and fell _8.3% yesterday. Investor concerns include a) possible
equity dilution to fund power projects and Australian coal mine acquisition
and b) highly geared balance sheet, causing an interest rate risk amidst
falling merchant prices.
• Concern # 1 – equity funding gap – valid, but not an immediate risk in
our view. In our estimate, Lanco would need additional equity funds of
US$500-600M over 3-4 years, assuming perfect execution of its growth
plans. This breaks down into a) US$100-150M for its recent Griffin coal
mine acquisition (total expenditure of US$750B, of which US$525M is
debt-funded and ~US$125M via internal cash earnings) and b) US$450-
500M for power projects (capex of US$5.1B between FY12-14, of which
US$2.7B is SPV-debt funded and US$1.9B via internal cash earnings). The
implied equity dilution is to the tune of 20%. However, we believe most of
the funds would be required in FY14. The company has said that it may IPO
its power vertical over the next 12 months.
• Concern # 2: high leverage and falling merchant prices: Est. consol
leverage is 4.3x and 4.7x in FY11 and12. As of Sep-10, 70% of the debt
was at SPV level, most of which are funded at 4:1. 41% of FY12 and 32%
of FY13 MW have an interest cost pass-through. A combination of 10%
lower merchant rates and 100bps higher interest rate would cause earnings
impact of 26% and 27% in FY12 and 13 on our estimates, and SOP impact
of Rs15 (18%). In a situation where liquidity is tight and risk aversion is
high, slowdown in loan disbursements to under-construction nonguaranteed
return projects (6.4GW, ~56% of SOP) could pose a risk to
growth.
• Silver lining: value from Griffin asset, decent execution ramp-up,
unlocking power value: At 7.9x EV/EBITDA, Lanco seems to have paid
a reasonable price for buying this 4mtpa coal asset at Australia. We see a
potential recovery in stock performance on the back of robust growth in
power generation and likely value unlocking at the power vertical,
subject to favourable market conditions. Continued tight liquidity
impacting project execution, lower gas availability and sharp decline in
merchant prices are the key risks to our OW call.
A close look at Griffin mine acquisition
Lanco Infratech entered into a binding agreement to purchase 100% share in Griffin
coal mines in mid-Dec-2010. The company acquired Griffin in a competitive bidding
process which saw 16 bidders (including other Chinese/ Korean and Indian players).
Eventually it was a close win for Lanco over GVK.
Mine details
Griffin coal, based out of Collie in Western Australia owns the largest operational
thermal coal mine in the region. The mine currently produces over 4MTPA of coal
and management expects to ramp up production to 17MTPA over next ~5years (we
est. 17MTPA throughput in FY19), post development of evacuation infrastructure.
The mining tenements contain ~1.1 billion tons of JORC compliant thermal coal
resources (including 310MMT of reserves). The coal is moderately superior to Indian
coal in quality specification- 4800Kcal/kg GCV, 21-24% moisture levels, 8-13% ash
and 0.5-0.75% ash content.
As per management, Griffin has existing manpower strength of 450+, with a proven
track record in mining. The mine is located on the western coast of Australia, and is
closer to India compared to the mines in the New South Wales and Queensland areas
of Australia. The coal mines are connected to two ports through both rail and road.
Bunbury is the nearest port from the mine located 85km away; Kwinana Port is
175km distant. Current rail and port infrastructure can handle up to 2MTPA of coal
exports from Griffin.
Funding and capex plans
According to management, overall purchase price for the acquisition will not exceed
US$750mn. The deal involves an upfront component (~US$475mn in our est.) and
two installments for balance payment thru FY15, in a manner that NPV of payments
do not exceed US$650mn. Subsequent to fulfillment of certain conditions set by the
seller, the transaction is expected to be complete 2-3months from now.
To augment mining and evacuation capacity to 17MTPA, management expects to
incur ~US$900MM capex over next 4 years.
Lanco expects to fund the acquisition and capex through a mix of internal accruals
and debt. They have obtained bridge financing from ICICI Bank over 3 years with an
option to extend it further. Management expects to convert these loans to nonrecourse
over Lanco's balance sheet.
Implied valuations of mine acquisition
The Griffin acquisition payout (US$650mn NPV) implies-
• EV of US$0.6/MT of resources & reserves. Our valuation of Tata Power’s
stake in Bumi's coal mines implies an EV/ton of US$1.36. The quality of
coal in Bumi mines is superior (6600GCV), adjusted to 4800Kcal/kg levels,
our valuation is ~US$1/MT.
• EV/ton of current production is US$162.5/MT, as compared to
US$213/MT for Bumi (adjusted for quality ~US$155/MT).
The acquisition appears reasonably priced given ramp up in volumes is subject to
risk of delays and cost overruns in development of evacuation infrastructure, in our
view.
Coal pricing, volume and costing assumptions
Lanco is committed to sell ~3MTPA of production to power, cement and aluminium
companies in Australia over the LT. The base FOB price is ~US$40/MT and an
annual inflation of 3.5% is allowed. Around FY15, Griffin is committed to sell
another 3MTPA of coal over the long term to a fertilizer company in Australia at
US$60/MT (FOB), future price increases to provide for inflation.
Due to domestic commitments, we expect Griffin’s exports to range between 1.5-
4.0MTPA thru FY17, limiting the upside potential of the acquisition.
We estimate reduction in mining cost/ton of ~US$25 (down ~10% in FY13), as per
management guidance.
Through the ownership of port and rail road capacity till Bunbury, Lanco expects to
reduce rail + port operating expenses from US$15/MT levels to US$4/MT in the long
term. This assumption appears aggressive in our view; we assume reduction to
~US10/MT levels in medium term. We estimate total sea-freight for exports at
~US$20/MT.
We have depreciated the asset @3.5% SLM and assume 8% interest cost (keeping a
buffer over management guidance of Libor+400bps).
Based on these assumptions we estimate FY12 PAT contribution of Rs819mn, est. to
grow to ~Rs4.8B by FY17.
In our base case we assume US$76.5/MT for export realization (growing at 3% p.a.),
and this yields neutral NPV in our FCF based valuation (15% discounting factor).
The valuation is quite sensitive to-
• Assumption of export realizations: A 5% higher est. increases NPV to
Rs6.26B and vice versa.
• Pace of production ramp up: Assuming ramp up to 17MTPA happens in
FY16 instead of FY19, NPV goes up to Rs8.5B.
Bottom-line
In our view, tightness in market for thermal grade coal (McCloskey’s coal price
index is up ~50% over last 5 months), and significant uncertainty in volume of
domestic supply vs. demand, make the Griffin acquisition a LT positive for Lanco to
secure its fuel needs. However, markets will assign value / upside only if Lanco
executes or delivers ramp-up in exports. Potential equity dilution for funding the
acquisition and mine, port and rail-road capex (besides power plant capex in India)
would precede the increase in volumes, in our view.
An overall view on B/S, cash flow and funding gap
Est. consol leverage is 4.3x and 4.7x in FY11 and12. As of Sep-10, 70% of the debt
was at SPV level, most of which are funded at 4:1. 41% of FY12 and 32% of FY13
MW have an interest cost pass-through. A combination of 10% lower merchant rates
and 100bps higher interest rate would cause earnings impact of 26% and 27% in
FY12 and 13 on our estimates, and SOP impact of Rs15 (18%). In a situation where
liquidity is tight and risk aversion is high, slowdown in loan disbursements to under
construction non-guaranteed return projects (6.4GW, ~56% of SOP) could pose a
risk to growth.
Although we expect Lanco to be OCF positive, on a FCF basis we expect the
company to turnaround in FY15 post a Rs23B equity infusion in FY14. Also we
expect capex investment for the 9.3GW currently in our estimates to come to an end
in FY14. That said the Griffin acquisition once consolidated into estimates could
further increase pressure on cash flows. We expect Griffin to be FCF positive FY16
onwards.
Worst case dilution: 20% in FY14
In our estimate, Lanco would need additional equity funds of US$500-600M
over 3-4 years, assuming perfect execution of its growth plans. This breaks down
into:
a) US$100-150M for its recent Griffin coal mine acquisition (total expenditure of
US$750B, of which US$525M is debt-funded and ~US$125M via internal cash
earnings).
b) US$450-500M for power projects (capex of US$5.1B between FY12-14, of
which US$2.7B is SPV-debt funded and US$1.9B via internal cash earnings).
The implied equity dilution is to the tune of 20%. However, we believe most of
the funds would be required in FY14. The company has said that it may IPO its
power vertical over the next 12 months.
Management is considering an IPO of its power business to be concluded within 12
months. The group is currently consolidating all its power projects under a single
company.
Recap of our OW thesis and assessment
of the downsides
The growth story for Lanco remains intact in our view –
• Aggressive capacity expansion plans: We expect sharp ramp up in capacity to
4.85GW by end of FY12 (vs. 2.1GW currently) and 9.3GW before FY15.
Management has a target to expand to 15GW by FY15 which includes 3.3GW
brown field expansion plans, land and clearances are relatively easier to
secure, in our view. We have factored in a buffer of at least 3months over CoD
guidance given by mgmt. for projects.
• Significant progress made on pipeline: Management has also placed a
16x660MW BTG order placed on Harbin, signaling a definite pipeline. Also debt
funds have been tied up for the entire under-construction pipeline. Tying up of
funds with Chinese banks could lower interest costs.
• Exposure to merchant rates: Lanco has high exposure to merchant rates; ~39%
of capacity has not yet been tied up in PPAs. We provide for a conservative
merchant assumption of Rs4 in FY12 declining to Rs3.26 by FY16, capping
downside risk to earnings. Downside of Rs14/share if merchant price is 10%
below estimate.
• Dependence on linkage coal: 4.74GW relies on coal linkage for which LoA has
been signed, 1GW on captive coal and 1.2GW on imported coal. We provide for
a risk in fuel supply with a 75-80% PLF est. for under implementation projects.
Downside of Rs6/share if PLF for linkage projects is 500bps below estimates.
• Reduced dependence on imported coal: Only Lanco’s Udupi project
(1,200MW) is based on imported coal, which has a full fuel cost pass through in
tariff.
Price target and Valuation
It appears the stock price correction adequately factors in a possible equity dilution,
and we see the correction as an opportunity to buy into IPP growth story with longterm
fuel security. We like Lanco as we see a decent scale-up in power generation,
and the % contribution from this segment will likely drive a re-rating. It appears our
estimates are lower than the street, mainly on account of conservative construction
margins.
Our Mar-12 SOP based PT of Rs82 implies ~70% upside potential over CMP.
Lanco is trading at 7.9x FY12 EV/EBITDA vs. average of 11x for the sector (ex-
RPWR). Our PT includes Rs64/share for operating and under construction power
projects, i.e. for the entire 9.3GW pipeline which has crossed stage of financial
closure and Rs19/share for the construction business. Our valuation for the
construction business implies a 6.7x FY12 EV/EBITDA multiple vs. 8.8x previously.
Execution delays and events deteriorating outlook on merchant prices are key risks to
estimates & price target.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
Lanco Infratech
Overweight
LAIN.BO, LANCI IN
Closer analysis of leverage and funding gap concerns
that have impacted stock performance
• Lanco has sharply underperformed its IPP peers over the last one
month, and fell _8.3% yesterday. Investor concerns include a) possible
equity dilution to fund power projects and Australian coal mine acquisition
and b) highly geared balance sheet, causing an interest rate risk amidst
falling merchant prices.
• Concern # 1 – equity funding gap – valid, but not an immediate risk in
our view. In our estimate, Lanco would need additional equity funds of
US$500-600M over 3-4 years, assuming perfect execution of its growth
plans. This breaks down into a) US$100-150M for its recent Griffin coal
mine acquisition (total expenditure of US$750B, of which US$525M is
debt-funded and ~US$125M via internal cash earnings) and b) US$450-
500M for power projects (capex of US$5.1B between FY12-14, of which
US$2.7B is SPV-debt funded and US$1.9B via internal cash earnings). The
implied equity dilution is to the tune of 20%. However, we believe most of
the funds would be required in FY14. The company has said that it may IPO
its power vertical over the next 12 months.
• Concern # 2: high leverage and falling merchant prices: Est. consol
leverage is 4.3x and 4.7x in FY11 and12. As of Sep-10, 70% of the debt
was at SPV level, most of which are funded at 4:1. 41% of FY12 and 32%
of FY13 MW have an interest cost pass-through. A combination of 10%
lower merchant rates and 100bps higher interest rate would cause earnings
impact of 26% and 27% in FY12 and 13 on our estimates, and SOP impact
of Rs15 (18%). In a situation where liquidity is tight and risk aversion is
high, slowdown in loan disbursements to under-construction nonguaranteed
return projects (6.4GW, ~56% of SOP) could pose a risk to
growth.
• Silver lining: value from Griffin asset, decent execution ramp-up,
unlocking power value: At 7.9x EV/EBITDA, Lanco seems to have paid
a reasonable price for buying this 4mtpa coal asset at Australia. We see a
potential recovery in stock performance on the back of robust growth in
power generation and likely value unlocking at the power vertical,
subject to favourable market conditions. Continued tight liquidity
impacting project execution, lower gas availability and sharp decline in
merchant prices are the key risks to our OW call.
A close look at Griffin mine acquisition
Lanco Infratech entered into a binding agreement to purchase 100% share in Griffin
coal mines in mid-Dec-2010. The company acquired Griffin in a competitive bidding
process which saw 16 bidders (including other Chinese/ Korean and Indian players).
Eventually it was a close win for Lanco over GVK.
Mine details
Griffin coal, based out of Collie in Western Australia owns the largest operational
thermal coal mine in the region. The mine currently produces over 4MTPA of coal
and management expects to ramp up production to 17MTPA over next ~5years (we
est. 17MTPA throughput in FY19), post development of evacuation infrastructure.
The mining tenements contain ~1.1 billion tons of JORC compliant thermal coal
resources (including 310MMT of reserves). The coal is moderately superior to Indian
coal in quality specification- 4800Kcal/kg GCV, 21-24% moisture levels, 8-13% ash
and 0.5-0.75% ash content.
As per management, Griffin has existing manpower strength of 450+, with a proven
track record in mining. The mine is located on the western coast of Australia, and is
closer to India compared to the mines in the New South Wales and Queensland areas
of Australia. The coal mines are connected to two ports through both rail and road.
Bunbury is the nearest port from the mine located 85km away; Kwinana Port is
175km distant. Current rail and port infrastructure can handle up to 2MTPA of coal
exports from Griffin.
Funding and capex plans
According to management, overall purchase price for the acquisition will not exceed
US$750mn. The deal involves an upfront component (~US$475mn in our est.) and
two installments for balance payment thru FY15, in a manner that NPV of payments
do not exceed US$650mn. Subsequent to fulfillment of certain conditions set by the
seller, the transaction is expected to be complete 2-3months from now.
To augment mining and evacuation capacity to 17MTPA, management expects to
incur ~US$900MM capex over next 4 years.
Lanco expects to fund the acquisition and capex through a mix of internal accruals
and debt. They have obtained bridge financing from ICICI Bank over 3 years with an
option to extend it further. Management expects to convert these loans to nonrecourse
over Lanco's balance sheet.
Implied valuations of mine acquisition
The Griffin acquisition payout (US$650mn NPV) implies-
• EV of US$0.6/MT of resources & reserves. Our valuation of Tata Power’s
stake in Bumi's coal mines implies an EV/ton of US$1.36. The quality of
coal in Bumi mines is superior (6600GCV), adjusted to 4800Kcal/kg levels,
our valuation is ~US$1/MT.
• EV/ton of current production is US$162.5/MT, as compared to
US$213/MT for Bumi (adjusted for quality ~US$155/MT).
The acquisition appears reasonably priced given ramp up in volumes is subject to
risk of delays and cost overruns in development of evacuation infrastructure, in our
view.
Coal pricing, volume and costing assumptions
Lanco is committed to sell ~3MTPA of production to power, cement and aluminium
companies in Australia over the LT. The base FOB price is ~US$40/MT and an
annual inflation of 3.5% is allowed. Around FY15, Griffin is committed to sell
another 3MTPA of coal over the long term to a fertilizer company in Australia at
US$60/MT (FOB), future price increases to provide for inflation.
Due to domestic commitments, we expect Griffin’s exports to range between 1.5-
4.0MTPA thru FY17, limiting the upside potential of the acquisition.
We estimate reduction in mining cost/ton of ~US$25 (down ~10% in FY13), as per
management guidance.
Through the ownership of port and rail road capacity till Bunbury, Lanco expects to
reduce rail + port operating expenses from US$15/MT levels to US$4/MT in the long
term. This assumption appears aggressive in our view; we assume reduction to
~US10/MT levels in medium term. We estimate total sea-freight for exports at
~US$20/MT.
We have depreciated the asset @3.5% SLM and assume 8% interest cost (keeping a
buffer over management guidance of Libor+400bps).
Based on these assumptions we estimate FY12 PAT contribution of Rs819mn, est. to
grow to ~Rs4.8B by FY17.
In our base case we assume US$76.5/MT for export realization (growing at 3% p.a.),
and this yields neutral NPV in our FCF based valuation (15% discounting factor).
The valuation is quite sensitive to-
• Assumption of export realizations: A 5% higher est. increases NPV to
Rs6.26B and vice versa.
• Pace of production ramp up: Assuming ramp up to 17MTPA happens in
FY16 instead of FY19, NPV goes up to Rs8.5B.
Bottom-line
In our view, tightness in market for thermal grade coal (McCloskey’s coal price
index is up ~50% over last 5 months), and significant uncertainty in volume of
domestic supply vs. demand, make the Griffin acquisition a LT positive for Lanco to
secure its fuel needs. However, markets will assign value / upside only if Lanco
executes or delivers ramp-up in exports. Potential equity dilution for funding the
acquisition and mine, port and rail-road capex (besides power plant capex in India)
would precede the increase in volumes, in our view.
An overall view on B/S, cash flow and funding gap
Est. consol leverage is 4.3x and 4.7x in FY11 and12. As of Sep-10, 70% of the debt
was at SPV level, most of which are funded at 4:1. 41% of FY12 and 32% of FY13
MW have an interest cost pass-through. A combination of 10% lower merchant rates
and 100bps higher interest rate would cause earnings impact of 26% and 27% in
FY12 and 13 on our estimates, and SOP impact of Rs15 (18%). In a situation where
liquidity is tight and risk aversion is high, slowdown in loan disbursements to under
construction non-guaranteed return projects (6.4GW, ~56% of SOP) could pose a
risk to growth.
Although we expect Lanco to be OCF positive, on a FCF basis we expect the
company to turnaround in FY15 post a Rs23B equity infusion in FY14. Also we
expect capex investment for the 9.3GW currently in our estimates to come to an end
in FY14. That said the Griffin acquisition once consolidated into estimates could
further increase pressure on cash flows. We expect Griffin to be FCF positive FY16
onwards.
Worst case dilution: 20% in FY14
In our estimate, Lanco would need additional equity funds of US$500-600M
over 3-4 years, assuming perfect execution of its growth plans. This breaks down
into:
a) US$100-150M for its recent Griffin coal mine acquisition (total expenditure of
US$750B, of which US$525M is debt-funded and ~US$125M via internal cash
earnings).
b) US$450-500M for power projects (capex of US$5.1B between FY12-14, of
which US$2.7B is SPV-debt funded and US$1.9B via internal cash earnings).
The implied equity dilution is to the tune of 20%. However, we believe most of
the funds would be required in FY14. The company has said that it may IPO its
power vertical over the next 12 months.
Management is considering an IPO of its power business to be concluded within 12
months. The group is currently consolidating all its power projects under a single
company.
Recap of our OW thesis and assessment
of the downsides
The growth story for Lanco remains intact in our view –
• Aggressive capacity expansion plans: We expect sharp ramp up in capacity to
4.85GW by end of FY12 (vs. 2.1GW currently) and 9.3GW before FY15.
Management has a target to expand to 15GW by FY15 which includes 3.3GW
brown field expansion plans, land and clearances are relatively easier to
secure, in our view. We have factored in a buffer of at least 3months over CoD
guidance given by mgmt. for projects.
• Significant progress made on pipeline: Management has also placed a
16x660MW BTG order placed on Harbin, signaling a definite pipeline. Also debt
funds have been tied up for the entire under-construction pipeline. Tying up of
funds with Chinese banks could lower interest costs.
• Exposure to merchant rates: Lanco has high exposure to merchant rates; ~39%
of capacity has not yet been tied up in PPAs. We provide for a conservative
merchant assumption of Rs4 in FY12 declining to Rs3.26 by FY16, capping
downside risk to earnings. Downside of Rs14/share if merchant price is 10%
below estimate.
• Dependence on linkage coal: 4.74GW relies on coal linkage for which LoA has
been signed, 1GW on captive coal and 1.2GW on imported coal. We provide for
a risk in fuel supply with a 75-80% PLF est. for under implementation projects.
Downside of Rs6/share if PLF for linkage projects is 500bps below estimates.
• Reduced dependence on imported coal: Only Lanco’s Udupi project
(1,200MW) is based on imported coal, which has a full fuel cost pass through in
tariff.
Price target and Valuation
It appears the stock price correction adequately factors in a possible equity dilution,
and we see the correction as an opportunity to buy into IPP growth story with longterm
fuel security. We like Lanco as we see a decent scale-up in power generation,
and the % contribution from this segment will likely drive a re-rating. It appears our
estimates are lower than the street, mainly on account of conservative construction
margins.
Our Mar-12 SOP based PT of Rs82 implies ~70% upside potential over CMP.
Lanco is trading at 7.9x FY12 EV/EBITDA vs. average of 11x for the sector (ex-
RPWR). Our PT includes Rs64/share for operating and under construction power
projects, i.e. for the entire 9.3GW pipeline which has crossed stage of financial
closure and Rs19/share for the construction business. Our valuation for the
construction business implies a 6.7x FY12 EV/EBITDA multiple vs. 8.8x previously.
Execution delays and events deteriorating outlook on merchant prices are key risks to
estimates & price target.
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