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LANCO Infratech Ltd
Weak Operational Performance; Look Forward to F2012; Maintain OW
What's Changed
Price Target Rs79.00 to Rs50.00
F2011e EPS Down 18%
F2012e EPS Up 14%
We maintain Overweight with price target of Rs50:
Our upgrade for Lanco in June 2010 was premised on
the potential for power business to become a larger
portion of the company’s revenue and EBITDA as more
power capacities are commissioned. We think this story
remains intact – but financial performance in 9MF11 was
weak due to delays in project commissioning, lower
merchant realization and tepid growth in the EPC
business (refer to our note dated February 7, 2011 for
analysis of F3Q11 earnings). However, we believe these
negatives are priced in with the stock underperforming
the Sensex by 41% in the last six months. We believe
F2012 EBITDA growth will be strong as an additional
2,612 MW of power capacity is added and construction
activity picks up.
Estimates cut: We have cut our EBITDA estimates for
F2011 and F2012 by 45% and 21%, respectively;
however, our F2012e earnings have increased due to
change in depreciation policy. However, valuations at
8.6x F2012 EV/EBITDA and 6x P/E look attractive.
Key developments: Over the last few months, the
company achieved financial closure for the Amarkantak
III and IV, Vidarbha, Babandh I and Kondapalli III
projects (aggregate capacity of 4,694 MW). In
December 2010, it announced the purchase of the
Griffin Coal assets in Australia for a total consideration
of AUD 750 mn. These assets have total resources of
1.1 bn tons and may reach peak output of 16-17 mtpa by
F2017, thus providing fuel security to its future projects.
Investment Thesis
• We believe Lanco is transitioning into
a serious player in the power industry,
with a likely installed capacity of 4,699
MW by F2012 making it one of the
largest private generation companies
in the country.
• The power business is becoming a
larger proportion of earnings, which
should lend higher visibility and
stability to the consolidated cash
flows of the company.
• Stock is trading at 8.6x F2012e
EV/EBITDA and 6x P/E, which is
attractive, in our view.
• For the entire projected capacity of
9,311 MW by F2014, the company
has ordered equipment and
commenced construction work.
Key Value Drivers
• Timely project execution.
• Regulatory regime improving in India.
Potential Catalysts
• Significant augmentation to the
construction order book, especially
from external orders.
• Increasing power portfolio
• Increasing merchant capacity or
merchant rates
Key Risks
• Execution delays in the power
projects.
• Lower margins in the construction
business
• Slowdown in capex spending or credit
freeze.
• Regulatory changes
Investment Case
We maintain our Overweight rating on Lanco with a new
price target of Rs50: This is pegged to our Base Case
scenario value. Our price target has been cut by 37% due to
lower construction valuation and weak operational
performance of the power business. We have cut our estimates
of F2011 EBITDA by 45% and for F2012 by 21%. However, our
profit estimate (before eliminations) for F2011 has gone down
by 18% only and F2012 has increased by 14%. This reflects a
change in the depreciation policy whereby the company has
gone back to the straight-line method from the written value
method it started applying for thermal power projects
commissioned after April 1, 2009. We understand that the
change in policy was to make valuation comparisons easier
(especially on P/E multiples) with its peer set.
Key changes in assumptions are:
• For F2011 we have factored in lower merchant realization,
delay in commissioning of Udupi and Anpara units and
muted performance of the EPC business.
• For F2012 we have assumed lower merchant realization
of Rs 4.2/unit and lower margins in the EPC business.
We continue to believe that Lanco holds the potential to
become a key player in the generation space and project
installed capacity of 4,699 MW by F2012. Valuation looks
attractive, in our view: the stock is trading at 8.6x F2012e
EV/EBITDA and 6x P/E.
Updates on power capacity addition
1. Amarkantak III & IV: The company is expanding these
projects by another 1,320 MW. They have received coal
linkages and have achieved financial closure.
Construction work has started and equipment has been
ordered on Harbin and Dongfang. The company plans to
sell 50% of the output through a PPA and the balance in
the merchant market. The commissioning timeline is
expected to be towards the end of F2014.
2. Kondapalli III: The company is expanding the project by
another two units aggregating 742 MW. The equipment
has been ordered on GE and construction work has
commenced. Financial closure for the project has been
achieved. The company expects commissioning in July
2011 for the single cycle and January 2012 for the
combined cycle. We have assumed that 50% of the output
will be sold on a PPA (under CERC norms) while the
balance will be sold in the merchant market. A gas supply
agreement will be signed a few months ahead of the
commissioning of the project.
3. Nagarjuna (Udupi): The first unit was commercialized in
November 2010 and the second unit is expected beyond
July 2011. The output will be sold on a PPA under CERC
norms and coal will be imported.
4. Babandh: This project will be built in two phases of 1,320
MW each. For Phase I, land for the main plant equipment
is in place, financial closure has been achieved, coal
linkage is available for 660 MW and a captive coal mine is
available for another 1,000 MW and equipment ordered on
Harbin and Dongfang. The commissioning timeline is
expected to be towards the end of F2014. We have
assumed that 50% of the output will be sold on a PPA
(under CERC norms) while the balance will be sold in the
merchant market. We have assumed Phase II in the Bull
Case scenario.
5. Vidarbha: Land for the main plant equipment is almost
fully in place, financial closure has been achieved, coal
linkage is available and equipment ordered on Harbin and
Dongfang. The commissioning timeline is expected to be
towards the end of F2014. We have assumed that 50% of
the output will be sold on a PPA (under CERC norms)
while the balance will be sold in the merchant market.
Details on Griffin Coal Acquisition
In December 2010, Lanco entered into a binding agreement to
purchase 100% of the shares of Griffin Coal Mining Company
Pty Ltd and Carpenter Mine Management Pty Ltd (Griffin Coal).
Griffin Coal is based in Collie (Western Australia) and has over
1.1 bn tonnes of JORC compliant thermal coal resources. The
mines are well connected to two ports through both rail and
road and the nearest port (Bunbury) is 85 kms away from the
mine.
Some of the key reasons for bidding for this coal asset are:
• Operating asset: Griffin currently produces 4.5 to 5 mtpa
of coal, which we believe can be immediately ramped up to
6 mtpa with some de-bottlenecking. Eventually, this mine
can be ramped upto 16-17 mtpa.
• Large resources: The mine currently has 1.1 bn tons of
JORC compliant resources with an additional potential of
100-150 mt. The extractable reserves are currently 310 mt,
which can be taken up to 700 mt with further exploration
over the next six months.
• Logistical advantage: The mine is located in Western
Australia, thus placing it closer to India relative to mines on
the eastern side and reducing freight cost by about AUD
4-5/ton. Also, the Bunbury port is only 85 kms away from
the mine translating into lower transportation cost (only
AUD 3-4/ton).
• Quality and cost of coal: The GCV of the coal is
4700-4800 kcal/kg with 21%-24% moisture content. Lanco
expects FOB price of AUD 50/ton initially, which may
decline with better efficiencies and economies of scale.
• Regulatory framework strong in Australia: Lanco
expects smooth operations given better policy
framework.
The total transaction value aggregates to AUD 750 million. It is
an all-cash deal and consists of an upfront payment (which we
believe may be about 50-60% of the total value) and two
installments which are spread over the next four years. None of
the existing debt and cash balances of the asset have been
transferred to Lanco. The transaction will be financed through a
mix of debt and equity – while the equity will come from existing
cash and internal accruals, the debt has been secured through
a bridge loan from ICICI Bank which has a tenor of three years
(with the option to extend). Lanco plans to convert this loan into
non-recourse at a future date. The loan has been given at
approximately LIBOR + 400 bps. We believe Lanco has the
balance sheet to support this transaction – we expect the
standalone debt:equity ratio to increase to 1.5:1 in F2011 and
1.7:1 in F2012 which we believe is reasonable.
In the next year, Lanco will try to improve operational
efficiencies and aim at increasing the extractable reserves.
Over the next 18 months, it will seek approvals to augment the
existing rail network (to set up a duplicate line) and port
capacity at Bunbury (additional berth). We believe capex
required for rail and port infrastructure and additional mining
equipment may exceed the AUD 900 mn estimated by the
company. However, this capex may decrease if the mining is
handed over to an MDO. During C2012, Lanco will start
construction on the rail and road infrastructure.
We estimate the company to increase production to 6 mtpa in
F2013, 12 mtpa by F2015 and 16 mtpa by F2017. Current
commitments from the mine are 3 mtpa towards domestic
consumption. Another 3 mtpa has been committed to a
domestic fertilizer company which will commence in 2015. As a
result, exportable coal available to Lanco post the ramp-up
maybe about 10-11 mtpa.
From a strategic perspective, we believe this acquisition was
necessary. Lanco’s future power plans were highly dependent
on regular coal supplies from Coal India. With this acquisition,
the portfolio gets de-risked somewhat due to availability of
captive coal, albeit at a higher cost. Also, it provides a
benchmark price to Lanco for participating in future Case I bids.
Financial Performance in 9MF2011
In 9MF2011, Lanco reported consolidated revenue of Rs57 bn
(flat YoY), EBITDA of Rs14.9 bn (up 68% YoY) and reported
profit of Rs 4.3 bn (up 24% YoY).
While the power business saw significant growth in revenue
and EBITDA largely due to additional capacity, the
performance was lower than our expectation, largely for the
following reasons:
1. Merchant realizations were low in 2Q and 3Q due to part
sales in the power exchange and UI market from
Amarkantak I and Kondapalli II.
2. Power volumes were lower due to lower PLF
3. Delays in commissioning of the Udupi and Anpara units
Performance in the construction segment too was weak due to
strong monsoons in F2Q11. While F2H11 is expected to be
stronger as new capacities start generating revenue, we
believe a reasonable impact will be seen only from F2012
onwards.
Valuation
We use a sum-of-the-parts valuation to arrive at our base case
scenario value of Rs50 for Lanco.
Key changes to our price target are due to the following:
• Merchant realization of Rs 3.8/unit in F2011 for
Kondapalli II and Rs 4.4/unit for Amarkantak I (from Rs
5/unit earlier)
• Merchant realization of Rs 4.2/unit in F2012 from Rs
5/unit earlier
• Changes to commissioning timelines of power projects
such as Anpara, Udupi and Lanco Green.
• Lower margins in the EPC business
• Rollover of our FCFe model for the power business to
F2012
• Lower P/E multiples for EPC peers
Power Business
We value the power business using the FCFe methodology, to
derive a base case value for the business of Rs43/share.
Exhibit 10 states our key assumptions for cost of equity
(unchanged overall, though beta and risk-free rate have
changed from before) and terminal growth rate (unchanged).
Exhibit 10
Key Assumptions
Equity beta 1.4
10-year risk free rate (%) 8.0%
Equity risk premium (%) 6.0%
Cost of equity (%) 16.5%
Terminal growth (%) 2%
Source: Morgan Stanley Research
Construction Business
The construction business is primarily focused on internal
projects, which should drive revenue and profits. We believe
that investors will benchmark valuations for Lanco’s
construction business against those of its Indian counterparts.
Given the nature of the business, we believe P/E multiples are
the best methodology for valuing companies in this industry in
India.
The F2012e P/E multiple of the company’s peer group is 3x.
Applying this to Lanco’s F2012e earnings, we arrive at a value
of Rs7/share. We have removed the discount of 20% to the
peer multiple that we were according earlier as multiples have
corrected significantly and reflect the risk involved with Lanco’s
construction business, in our view.
Exhibit 12
Lanco Infratech: Construction Business
F2012E construction earnings (Rs mn) 5,230
P/E peer multiple (x) 3.0
Discount (%) 0%
Target multiple (x) 3.0
Value per share (Rs/share) 7
Source: Morgan Stanley Research
E = Morgan Stanley Research estimates
Exhibit 13
India Construction Comparables – P/E
F2012
IVRCL 2.5
Nagarjuna 3.5
Average 3.0
Source: Morgan Stanley Research
Risks to Our Target Price
The key downside risks to our target price are:
• Delays in the construction of power projects
• Decline in margins in the construction business
• Delay in sale/lease out of real estate projects
• Increase in funding costs or non-availability of credit
The key catalysts to our target are:
• Increase in power project portfolio
• Better margins in the construction business
• Pickup in real estate demand in Hyderabad and Chennai
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
LANCO Infratech Ltd
Weak Operational Performance; Look Forward to F2012; Maintain OW
What's Changed
Price Target Rs79.00 to Rs50.00
F2011e EPS Down 18%
F2012e EPS Up 14%
We maintain Overweight with price target of Rs50:
Our upgrade for Lanco in June 2010 was premised on
the potential for power business to become a larger
portion of the company’s revenue and EBITDA as more
power capacities are commissioned. We think this story
remains intact – but financial performance in 9MF11 was
weak due to delays in project commissioning, lower
merchant realization and tepid growth in the EPC
business (refer to our note dated February 7, 2011 for
analysis of F3Q11 earnings). However, we believe these
negatives are priced in with the stock underperforming
the Sensex by 41% in the last six months. We believe
F2012 EBITDA growth will be strong as an additional
2,612 MW of power capacity is added and construction
activity picks up.
Estimates cut: We have cut our EBITDA estimates for
F2011 and F2012 by 45% and 21%, respectively;
however, our F2012e earnings have increased due to
change in depreciation policy. However, valuations at
8.6x F2012 EV/EBITDA and 6x P/E look attractive.
Key developments: Over the last few months, the
company achieved financial closure for the Amarkantak
III and IV, Vidarbha, Babandh I and Kondapalli III
projects (aggregate capacity of 4,694 MW). In
December 2010, it announced the purchase of the
Griffin Coal assets in Australia for a total consideration
of AUD 750 mn. These assets have total resources of
1.1 bn tons and may reach peak output of 16-17 mtpa by
F2017, thus providing fuel security to its future projects.
Investment Thesis
• We believe Lanco is transitioning into
a serious player in the power industry,
with a likely installed capacity of 4,699
MW by F2012 making it one of the
largest private generation companies
in the country.
• The power business is becoming a
larger proportion of earnings, which
should lend higher visibility and
stability to the consolidated cash
flows of the company.
• Stock is trading at 8.6x F2012e
EV/EBITDA and 6x P/E, which is
attractive, in our view.
• For the entire projected capacity of
9,311 MW by F2014, the company
has ordered equipment and
commenced construction work.
Key Value Drivers
• Timely project execution.
• Regulatory regime improving in India.
Potential Catalysts
• Significant augmentation to the
construction order book, especially
from external orders.
• Increasing power portfolio
• Increasing merchant capacity or
merchant rates
Key Risks
• Execution delays in the power
projects.
• Lower margins in the construction
business
• Slowdown in capex spending or credit
freeze.
• Regulatory changes
Investment Case
We maintain our Overweight rating on Lanco with a new
price target of Rs50: This is pegged to our Base Case
scenario value. Our price target has been cut by 37% due to
lower construction valuation and weak operational
performance of the power business. We have cut our estimates
of F2011 EBITDA by 45% and for F2012 by 21%. However, our
profit estimate (before eliminations) for F2011 has gone down
by 18% only and F2012 has increased by 14%. This reflects a
change in the depreciation policy whereby the company has
gone back to the straight-line method from the written value
method it started applying for thermal power projects
commissioned after April 1, 2009. We understand that the
change in policy was to make valuation comparisons easier
(especially on P/E multiples) with its peer set.
Key changes in assumptions are:
• For F2011 we have factored in lower merchant realization,
delay in commissioning of Udupi and Anpara units and
muted performance of the EPC business.
• For F2012 we have assumed lower merchant realization
of Rs 4.2/unit and lower margins in the EPC business.
We continue to believe that Lanco holds the potential to
become a key player in the generation space and project
installed capacity of 4,699 MW by F2012. Valuation looks
attractive, in our view: the stock is trading at 8.6x F2012e
EV/EBITDA and 6x P/E.
Updates on power capacity addition
1. Amarkantak III & IV: The company is expanding these
projects by another 1,320 MW. They have received coal
linkages and have achieved financial closure.
Construction work has started and equipment has been
ordered on Harbin and Dongfang. The company plans to
sell 50% of the output through a PPA and the balance in
the merchant market. The commissioning timeline is
expected to be towards the end of F2014.
2. Kondapalli III: The company is expanding the project by
another two units aggregating 742 MW. The equipment
has been ordered on GE and construction work has
commenced. Financial closure for the project has been
achieved. The company expects commissioning in July
2011 for the single cycle and January 2012 for the
combined cycle. We have assumed that 50% of the output
will be sold on a PPA (under CERC norms) while the
balance will be sold in the merchant market. A gas supply
agreement will be signed a few months ahead of the
commissioning of the project.
3. Nagarjuna (Udupi): The first unit was commercialized in
November 2010 and the second unit is expected beyond
July 2011. The output will be sold on a PPA under CERC
norms and coal will be imported.
4. Babandh: This project will be built in two phases of 1,320
MW each. For Phase I, land for the main plant equipment
is in place, financial closure has been achieved, coal
linkage is available for 660 MW and a captive coal mine is
available for another 1,000 MW and equipment ordered on
Harbin and Dongfang. The commissioning timeline is
expected to be towards the end of F2014. We have
assumed that 50% of the output will be sold on a PPA
(under CERC norms) while the balance will be sold in the
merchant market. We have assumed Phase II in the Bull
Case scenario.
5. Vidarbha: Land for the main plant equipment is almost
fully in place, financial closure has been achieved, coal
linkage is available and equipment ordered on Harbin and
Dongfang. The commissioning timeline is expected to be
towards the end of F2014. We have assumed that 50% of
the output will be sold on a PPA (under CERC norms)
while the balance will be sold in the merchant market.
Details on Griffin Coal Acquisition
In December 2010, Lanco entered into a binding agreement to
purchase 100% of the shares of Griffin Coal Mining Company
Pty Ltd and Carpenter Mine Management Pty Ltd (Griffin Coal).
Griffin Coal is based in Collie (Western Australia) and has over
1.1 bn tonnes of JORC compliant thermal coal resources. The
mines are well connected to two ports through both rail and
road and the nearest port (Bunbury) is 85 kms away from the
mine.
Some of the key reasons for bidding for this coal asset are:
• Operating asset: Griffin currently produces 4.5 to 5 mtpa
of coal, which we believe can be immediately ramped up to
6 mtpa with some de-bottlenecking. Eventually, this mine
can be ramped upto 16-17 mtpa.
• Large resources: The mine currently has 1.1 bn tons of
JORC compliant resources with an additional potential of
100-150 mt. The extractable reserves are currently 310 mt,
which can be taken up to 700 mt with further exploration
over the next six months.
• Logistical advantage: The mine is located in Western
Australia, thus placing it closer to India relative to mines on
the eastern side and reducing freight cost by about AUD
4-5/ton. Also, the Bunbury port is only 85 kms away from
the mine translating into lower transportation cost (only
AUD 3-4/ton).
• Quality and cost of coal: The GCV of the coal is
4700-4800 kcal/kg with 21%-24% moisture content. Lanco
expects FOB price of AUD 50/ton initially, which may
decline with better efficiencies and economies of scale.
• Regulatory framework strong in Australia: Lanco
expects smooth operations given better policy
framework.
The total transaction value aggregates to AUD 750 million. It is
an all-cash deal and consists of an upfront payment (which we
believe may be about 50-60% of the total value) and two
installments which are spread over the next four years. None of
the existing debt and cash balances of the asset have been
transferred to Lanco. The transaction will be financed through a
mix of debt and equity – while the equity will come from existing
cash and internal accruals, the debt has been secured through
a bridge loan from ICICI Bank which has a tenor of three years
(with the option to extend). Lanco plans to convert this loan into
non-recourse at a future date. The loan has been given at
approximately LIBOR + 400 bps. We believe Lanco has the
balance sheet to support this transaction – we expect the
standalone debt:equity ratio to increase to 1.5:1 in F2011 and
1.7:1 in F2012 which we believe is reasonable.
In the next year, Lanco will try to improve operational
efficiencies and aim at increasing the extractable reserves.
Over the next 18 months, it will seek approvals to augment the
existing rail network (to set up a duplicate line) and port
capacity at Bunbury (additional berth). We believe capex
required for rail and port infrastructure and additional mining
equipment may exceed the AUD 900 mn estimated by the
company. However, this capex may decrease if the mining is
handed over to an MDO. During C2012, Lanco will start
construction on the rail and road infrastructure.
We estimate the company to increase production to 6 mtpa in
F2013, 12 mtpa by F2015 and 16 mtpa by F2017. Current
commitments from the mine are 3 mtpa towards domestic
consumption. Another 3 mtpa has been committed to a
domestic fertilizer company which will commence in 2015. As a
result, exportable coal available to Lanco post the ramp-up
maybe about 10-11 mtpa.
From a strategic perspective, we believe this acquisition was
necessary. Lanco’s future power plans were highly dependent
on regular coal supplies from Coal India. With this acquisition,
the portfolio gets de-risked somewhat due to availability of
captive coal, albeit at a higher cost. Also, it provides a
benchmark price to Lanco for participating in future Case I bids.
Financial Performance in 9MF2011
In 9MF2011, Lanco reported consolidated revenue of Rs57 bn
(flat YoY), EBITDA of Rs14.9 bn (up 68% YoY) and reported
profit of Rs 4.3 bn (up 24% YoY).
While the power business saw significant growth in revenue
and EBITDA largely due to additional capacity, the
performance was lower than our expectation, largely for the
following reasons:
1. Merchant realizations were low in 2Q and 3Q due to part
sales in the power exchange and UI market from
Amarkantak I and Kondapalli II.
2. Power volumes were lower due to lower PLF
3. Delays in commissioning of the Udupi and Anpara units
Performance in the construction segment too was weak due to
strong monsoons in F2Q11. While F2H11 is expected to be
stronger as new capacities start generating revenue, we
believe a reasonable impact will be seen only from F2012
onwards.
Valuation
We use a sum-of-the-parts valuation to arrive at our base case
scenario value of Rs50 for Lanco.
Key changes to our price target are due to the following:
• Merchant realization of Rs 3.8/unit in F2011 for
Kondapalli II and Rs 4.4/unit for Amarkantak I (from Rs
5/unit earlier)
• Merchant realization of Rs 4.2/unit in F2012 from Rs
5/unit earlier
• Changes to commissioning timelines of power projects
such as Anpara, Udupi and Lanco Green.
• Lower margins in the EPC business
• Rollover of our FCFe model for the power business to
F2012
• Lower P/E multiples for EPC peers
Power Business
We value the power business using the FCFe methodology, to
derive a base case value for the business of Rs43/share.
Exhibit 10 states our key assumptions for cost of equity
(unchanged overall, though beta and risk-free rate have
changed from before) and terminal growth rate (unchanged).
Exhibit 10
Key Assumptions
Equity beta 1.4
10-year risk free rate (%) 8.0%
Equity risk premium (%) 6.0%
Cost of equity (%) 16.5%
Terminal growth (%) 2%
Source: Morgan Stanley Research
Construction Business
The construction business is primarily focused on internal
projects, which should drive revenue and profits. We believe
that investors will benchmark valuations for Lanco’s
construction business against those of its Indian counterparts.
Given the nature of the business, we believe P/E multiples are
the best methodology for valuing companies in this industry in
India.
The F2012e P/E multiple of the company’s peer group is 3x.
Applying this to Lanco’s F2012e earnings, we arrive at a value
of Rs7/share. We have removed the discount of 20% to the
peer multiple that we were according earlier as multiples have
corrected significantly and reflect the risk involved with Lanco’s
construction business, in our view.
Exhibit 12
Lanco Infratech: Construction Business
F2012E construction earnings (Rs mn) 5,230
P/E peer multiple (x) 3.0
Discount (%) 0%
Target multiple (x) 3.0
Value per share (Rs/share) 7
Source: Morgan Stanley Research
E = Morgan Stanley Research estimates
Exhibit 13
India Construction Comparables – P/E
F2012
IVRCL 2.5
Nagarjuna 3.5
Average 3.0
Source: Morgan Stanley Research
Risks to Our Target Price
The key downside risks to our target price are:
• Delays in the construction of power projects
• Decline in margins in the construction business
• Delay in sale/lease out of real estate projects
• Increase in funding costs or non-availability of credit
The key catalysts to our target are:
• Increase in power project portfolio
• Better margins in the construction business
• Pickup in real estate demand in Hyderabad and Chennai
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