Citi: Lanco Infratech - Collapsing Merchant Prices Hurt 3QFY11

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Lanco Infratech (LAIN.BO) 
 Collapsing Merchant Prices Hurt 3QFY11 
 
 3QFY11 adjusted PAT 24% below estimates – LANCI’s 3QFY11 adjusted PAT at
Rs914mn fell 14% YoY and was 24% below CIRA’s estimate of Rs1.2bn. Merchant
prices at Rs3.8/kwh were 13% below CIRA’s estimate of Rs4.35. We note that
adjusted numbers are not strictly comparables to CIRA estimates as we had
factored in WDV depreciation at ~14% rates while adjusted numbers factor in SLM
depreciation for 3QFY11.

 EBITDA 13% below estimates – EBITDA (including Udupi) at Rs5.03bn was up
67% YoY and was 13% below CIRA estimates due to lower merchant prices and
slightly lower generation.
 Change in depreciation policy in 3QFY11 – LANCI has reverted back to SLM
method of depreciation from WDV in 3QFY11. The company has reverted back
earlier period depreciation expenses of Rs3.02bn in 3QFY11. The company has
also accounted for the Udupi (1200MW) project as an associate as the 2nd  unit is
yet to be commissioned which impacted reported revenue and EBITDA numbers.
 Capital raising ahead?  – WDV method was depressing reported PAT (while
saving on taxes). A move to revert to SLM could be a precursor to eventual capital
raising. LANCI has D/E (including major associates) of 4.14x. As a result of
reversal to SLM, LANCI would appear more reasonably valued on P/E multiples.
 Execution picked up significantly in quarter – which is evident from Rs20bn of
EPC revenues (up 53% YoY, 68% ahead of estimates). Execution on Amarkantak
3&4 and Kondaplli phase 3 has picked up momentum. However as these projects
are accounted for as subsidiaries, the company had to eliminate ~67% of EPC
revenue on consolidation, resulting in higher effective tax rates and lower profits at
consolidated level. We will get back with more details after the management
conference call.


Lanco Infratech
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 Rs78/share with EPC at Rs19/share (11x
Mar12 EPS), Power at Rs58/share (DCF on FCFE using 13% CoE), Roads at
Rs2/share (DCF on FCFE using 13% CoE) and other businesses at Rs(-
1.5)/share.

Risks
Our quantitative risk-rating system, which tracks 260-day historical share price
volatility, assigns a Medium Risk rating to Lanco Infratech, which we believe is
appropriate, given the status of projects under implementation, industry-specific
risks, financial risk and management risks. LANCI's Medium Risk rating is
supported by: 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 ~75-
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.