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UBS Investment Research
Key Call: Lanco Infratech
Post big correction, what all is priced in?
Extreme and unrealistic pessimism is factored in the current stock price
After today’s sharp correction post 3Q FY11 results, we believe the current stock
price is factoring in almost all possible negatives. This includes: a) sharp decline in
merchant tariff realisations and a long-term tariff of Rs2.5/unit, 2) fuel cost pass
through not being allowed even if it is permissible under PPAs, 3) non-completion
of new 4,700MW projects, 4) interest rate hikes. We believe such a scenario is
highly unlikely that all the negatives would play out simultaneously.
What could be the impact of lower merchant tariffs?
On a blended basis, the merchant tariff for 9M FY11 has been Rs4.5/unit (vs.
UBSe of Rs5.25.unit) for Lanco. Overall, if we assume a decline of Rs1/unit in
merchant tariffs vs. our estimates (effectively for example Rs4.25/unit for FY11
and Rs4/unit for FY12), the valuation impact is ~11%. However, we believe that
merchant tariff realisations should improve in 4Q FY11 and 1Q FY12.
Is fuel cost pass-through for power projects at risk?
There are concerns that there could be impact on profitability of projects if the
linkage coal shortfall is met with imported coal. We believe the projects with fuel
cost pass-through are not at risk and though the approvals are required from SEBs,
the issue is largely technical. Overall, the potential valuation impact is ~12% for a
10% increase in coal prices (if the company is not able to pass on the costs).
Valuation: Maintain Buy rating and price target of Rs105
Our price target of Lanco (UBS Asia Key Call) is derived on SoTP basis. We value
Lanco as a conglomerate with power contributing 66% of valuation and EPC 28%.
Key risks and potential valuation impact
The key risks and their valuation impact are as follows;
Table 1: The key risks and their valuation impact
Assumption Valuation impact
1 Merchant tariff Rs1/unit decline 11%
2 Fuel Cost 10% increase with pass through not being allowed 12%
3 Interest Cost 1% hike in interest cost 14%
4 Multiple for EPC business Cut by 50%, from 6xFY12 EBITDA to 3x 13%
Total combined impact 56%
Effective valuation/share from current PT Rs105 Rs46
Source: UBS estimates
This indicates that after today’s sharp correction, we believe the current stock
price is factoring in almost all possible negatives. This includes: a) sharp decline
in merchant tariff realisations and a long-term tariff of Rs2.5/unit, 2) fuel cost
pass through not being permitted even when it is permissible under PPAs, 3)
non-completion of new 4,700MW projects, 4) interest rate hikes.
We believe such a scenario is not realistic that all the negatives would play out
simultaneously.
We believe that merchant tariff realisations should improve in 4Q FY11 and 1Q
FY12. However, if we assume a decline of Rs1/unit in merchant tariffs vs. our
estimates, the valuation impact is ~11%.
However, we think Rs2.5/unit for long-term is not realistic as already the longterm
PPAs are being signed at Rs3-3.25/unit.
Fuel cost risk
There are concerns that there could be impact on profitability of projects if the
linkage coal shortfall is met with imported coal. We believe the projects with
fuel cost pass through are not at risk and though the approvals are required from
SEBs, the issue is largely technical.
Overall, the potential valuation impact is ~12% for a 10% increase in coal prices
(if the company is not able to pass on the costs).
Interest cost risk
In the high inflation environment, there are concerns that the RBI may hike the
interest rates and this could impact the profitability of projects. We believe this
issue is valid. However, the impact is much lower for already completed and
operational projects. Currently, we assume 10.5% interest cost for completed
projects and 12% for under construction projects which we believe is reasonable.
Still, there could be a 14% overall valuation impact if the cost of borrowing
increases by 100bps for the projects.
Multiple for EPC business
The EPC and construction business order book stands at Rs275bn. We are
convinced on the capability of Lanco’s EPC division and believe the recent
external order wins (1,200MW coal-based power project contract from Moser
Baer and BoP package contract from Mahagenco for the 1,980 MW Koradi
Thermal Power Plant) are also positive. We currently use 6x FY12 EBITDA
multiple for this business and it contributes Rs25 in SoTP.
If we cut the multiple by 50%, from 6x FY12 EBITDA to 3x, the valuation
impact is 13%.
Other key issues
Change in depreciation policy
In 3Q FY11, the company has changed its deprecation policy to Straight line
from WDV.
In our view, a possible objective was to make 3Q profitability look more
respectable. Had the company continued with WDV, the reported PAT would
have been Rs310m.
We do believe that frequent changes in significant accounting policies (such as
depreciation) are not really good. However, we also think there is no real impact
of this particular change on business.
Merchant power
Lanco is trying to de-risk their portfolio and would maintain 75% long-term and
25% merchant as their strategy. They have also indicated that the merchant
tariffs have improved in this quarter to about Rs4.25-5.5/unit.
Udupi plant reported loss
Revenues recognised on interim tariff basis (Rs3.12/unit) while the actual tariff
should be Rs3.6-3.7. This is to be approved by Karantaka state as the fuel cost
was higher. The approval is expected in this quarter.
Anpara fuel requirement
If coal India is not able to supply required quantity, blending (with e-auction
coal) would continue for Anpara. Fuel cost is a pass through and the company
believes that UP government would be fine with procuring power even at
Rs3.5/unit (if 100% coal is imported).
Key takeaways from concall
SEBs’ losses
- Reasonable to assume Rs4.5/unit for merchant
- Overall procurement is 10% through merchant market, so not a significant
burden for SEBs
Anpara commissioning
- Unit 1 synchronisation in early March, commissioning in April. The unit is
mechanically ready.
- Unit 2 synchronisation in April
Kondapalli
- Unit 1 shutdown for 12 days (planned maintenance), currently 90% of fuel is
supplied by RIL
- Generation should be reasonable, don’t see any issues for 75-80% PLFs
Higher revenue elimination
- EPC revenues contributed more from Kondapalli and Amarkantak
- Babandh is still an associate
Amarkantak Unit 2
- should remain on UI during 4Q
- FY12 is subject to discussion with PTC and Haryana Govt
Scheduled shutdown
- None for 4Q as of now
- Unplanned cant be forecasted
Heat rate for Amarkantak
- 2400kcal/unit for Unit 1 and 2500kcal/Unit for Unit 2
- 2380 kcal/unit on yearly basis
Kondapalli expansion
- Construction activity is as per schedule
- Gas should be available hopefully
3Q FY11: Consolidated results
In 3Q FY11, Lanco’s net sales declined 3% YoY to Rs15.62bn primarily due to
lower power trading revenues. EBITDA increased 57% YoY to Rs4.8bn due to
lower raw material costs. Reported PAT was up 54% YoY to Rs1.64bn.
However, adjusted for forex gain (Rs140m), recurring PAT was up 59% YoY to
Rs1.5bn. The company has changed its deprecation policy to Straight line from
WDV
Lanco Infratech
Lanco Infratech Limited (Lanco), established in 1993, is an integrated
infrastructure developer with interests in power, infrastructure, construction and
real estate. Lanco is among the leading private sector power generation
companies. It has a captive construction division that directly benefits from the
award of in-house power, real estate and infrastructure projects.
Statement of Risk
We believe the key risks for the power business are: fuel availability and
linkages, execution and operation of power plants, and payment security for
merchant power. Key risks for the real estate business include India’s interest
rate outlook, recession in property prices, escalation in construction costs, a
potential slowdown in IT spending, and regulatory and legal risks. The
construction business and infrastructure development streams may suffer due to
execution and order inflows, policy risk, and commodity price increases,
especially in cement and steel.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Key Call: Lanco Infratech
Post big correction, what all is priced in?
Extreme and unrealistic pessimism is factored in the current stock price
After today’s sharp correction post 3Q FY11 results, we believe the current stock
price is factoring in almost all possible negatives. This includes: a) sharp decline in
merchant tariff realisations and a long-term tariff of Rs2.5/unit, 2) fuel cost pass
through not being allowed even if it is permissible under PPAs, 3) non-completion
of new 4,700MW projects, 4) interest rate hikes. We believe such a scenario is
highly unlikely that all the negatives would play out simultaneously.
What could be the impact of lower merchant tariffs?
On a blended basis, the merchant tariff for 9M FY11 has been Rs4.5/unit (vs.
UBSe of Rs5.25.unit) for Lanco. Overall, if we assume a decline of Rs1/unit in
merchant tariffs vs. our estimates (effectively for example Rs4.25/unit for FY11
and Rs4/unit for FY12), the valuation impact is ~11%. However, we believe that
merchant tariff realisations should improve in 4Q FY11 and 1Q FY12.
Is fuel cost pass-through for power projects at risk?
There are concerns that there could be impact on profitability of projects if the
linkage coal shortfall is met with imported coal. We believe the projects with fuel
cost pass-through are not at risk and though the approvals are required from SEBs,
the issue is largely technical. Overall, the potential valuation impact is ~12% for a
10% increase in coal prices (if the company is not able to pass on the costs).
Valuation: Maintain Buy rating and price target of Rs105
Our price target of Lanco (UBS Asia Key Call) is derived on SoTP basis. We value
Lanco as a conglomerate with power contributing 66% of valuation and EPC 28%.
Key risks and potential valuation impact
The key risks and their valuation impact are as follows;
Table 1: The key risks and their valuation impact
Assumption Valuation impact
1 Merchant tariff Rs1/unit decline 11%
2 Fuel Cost 10% increase with pass through not being allowed 12%
3 Interest Cost 1% hike in interest cost 14%
4 Multiple for EPC business Cut by 50%, from 6xFY12 EBITDA to 3x 13%
Total combined impact 56%
Effective valuation/share from current PT Rs105 Rs46
Source: UBS estimates
This indicates that after today’s sharp correction, we believe the current stock
price is factoring in almost all possible negatives. This includes: a) sharp decline
in merchant tariff realisations and a long-term tariff of Rs2.5/unit, 2) fuel cost
pass through not being permitted even when it is permissible under PPAs, 3)
non-completion of new 4,700MW projects, 4) interest rate hikes.
We believe such a scenario is not realistic that all the negatives would play out
simultaneously.
We believe that merchant tariff realisations should improve in 4Q FY11 and 1Q
FY12. However, if we assume a decline of Rs1/unit in merchant tariffs vs. our
estimates, the valuation impact is ~11%.
However, we think Rs2.5/unit for long-term is not realistic as already the longterm
PPAs are being signed at Rs3-3.25/unit.
Fuel cost risk
There are concerns that there could be impact on profitability of projects if the
linkage coal shortfall is met with imported coal. We believe the projects with
fuel cost pass through are not at risk and though the approvals are required from
SEBs, the issue is largely technical.
Overall, the potential valuation impact is ~12% for a 10% increase in coal prices
(if the company is not able to pass on the costs).
Interest cost risk
In the high inflation environment, there are concerns that the RBI may hike the
interest rates and this could impact the profitability of projects. We believe this
issue is valid. However, the impact is much lower for already completed and
operational projects. Currently, we assume 10.5% interest cost for completed
projects and 12% for under construction projects which we believe is reasonable.
Still, there could be a 14% overall valuation impact if the cost of borrowing
increases by 100bps for the projects.
Multiple for EPC business
The EPC and construction business order book stands at Rs275bn. We are
convinced on the capability of Lanco’s EPC division and believe the recent
external order wins (1,200MW coal-based power project contract from Moser
Baer and BoP package contract from Mahagenco for the 1,980 MW Koradi
Thermal Power Plant) are also positive. We currently use 6x FY12 EBITDA
multiple for this business and it contributes Rs25 in SoTP.
If we cut the multiple by 50%, from 6x FY12 EBITDA to 3x, the valuation
impact is 13%.
Other key issues
Change in depreciation policy
In 3Q FY11, the company has changed its deprecation policy to Straight line
from WDV.
In our view, a possible objective was to make 3Q profitability look more
respectable. Had the company continued with WDV, the reported PAT would
have been Rs310m.
We do believe that frequent changes in significant accounting policies (such as
depreciation) are not really good. However, we also think there is no real impact
of this particular change on business.
Merchant power
Lanco is trying to de-risk their portfolio and would maintain 75% long-term and
25% merchant as their strategy. They have also indicated that the merchant
tariffs have improved in this quarter to about Rs4.25-5.5/unit.
Udupi plant reported loss
Revenues recognised on interim tariff basis (Rs3.12/unit) while the actual tariff
should be Rs3.6-3.7. This is to be approved by Karantaka state as the fuel cost
was higher. The approval is expected in this quarter.
Anpara fuel requirement
If coal India is not able to supply required quantity, blending (with e-auction
coal) would continue for Anpara. Fuel cost is a pass through and the company
believes that UP government would be fine with procuring power even at
Rs3.5/unit (if 100% coal is imported).
Key takeaways from concall
SEBs’ losses
- Reasonable to assume Rs4.5/unit for merchant
- Overall procurement is 10% through merchant market, so not a significant
burden for SEBs
Anpara commissioning
- Unit 1 synchronisation in early March, commissioning in April. The unit is
mechanically ready.
- Unit 2 synchronisation in April
Kondapalli
- Unit 1 shutdown for 12 days (planned maintenance), currently 90% of fuel is
supplied by RIL
- Generation should be reasonable, don’t see any issues for 75-80% PLFs
Higher revenue elimination
- EPC revenues contributed more from Kondapalli and Amarkantak
- Babandh is still an associate
Amarkantak Unit 2
- should remain on UI during 4Q
- FY12 is subject to discussion with PTC and Haryana Govt
Scheduled shutdown
- None for 4Q as of now
- Unplanned cant be forecasted
Heat rate for Amarkantak
- 2400kcal/unit for Unit 1 and 2500kcal/Unit for Unit 2
- 2380 kcal/unit on yearly basis
Kondapalli expansion
- Construction activity is as per schedule
- Gas should be available hopefully
3Q FY11: Consolidated results
In 3Q FY11, Lanco’s net sales declined 3% YoY to Rs15.62bn primarily due to
lower power trading revenues. EBITDA increased 57% YoY to Rs4.8bn due to
lower raw material costs. Reported PAT was up 54% YoY to Rs1.64bn.
However, adjusted for forex gain (Rs140m), recurring PAT was up 59% YoY to
Rs1.5bn. The company has changed its deprecation policy to Straight line from
WDV
Lanco Infratech
Lanco Infratech Limited (Lanco), established in 1993, is an integrated
infrastructure developer with interests in power, infrastructure, construction and
real estate. Lanco is among the leading private sector power generation
companies. It has a captive construction division that directly benefits from the
award of in-house power, real estate and infrastructure projects.
Statement of Risk
We believe the key risks for the power business are: fuel availability and
linkages, execution and operation of power plants, and payment security for
merchant power. Key risks for the real estate business include India’s interest
rate outlook, recession in property prices, escalation in construction costs, a
potential slowdown in IT spending, and regulatory and legal risks. The
construction business and infrastructure development streams may suffer due to
execution and order inflows, policy risk, and commodity price increases,
especially in cement and steel.
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