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Lanco Infratech (65)
Utilities
Excessively flayed over macro concerns. Lanco Infratech has underperformed the
broader market by 32% and our utility coverage universe by 26% (last three months)
on macro concerns surrounding (1) softening merchant tariffs, and (2) availability and
pricing of fuel, further compounded by the company’s frequent changes in accounting
policies. In our view, the CMP sufficiently factors the risks to earnings from macro
issues. We reiterate our BUY rating with a revised target price of Rs65/share.
Stress-case assumptions also suggest upside from CMP
LITL has underperformed the BSE-30 index by 32% in the past three months as frequent shuffling
of depreciation policy (along with general macro headwinds for the sector) has rattled investor
sentiment. Even if we adjust for lower plant load factors, the potential upside is significant. To
illustrate: A reduction by 15% due to constrained coal availability and reduction in sustainable
merchant tariffs would give Rs3/kwh (our base-case assumption is Rs3.5/kwh), the implied value of
Rs45/share would therefore offer 18% upside to the CMP. Alternatively, a modest 1.5X P/B
(assuming regulated cost-plus returns) on the already invested equity of Rs61 bn (Rs25/share) for
7,900 MW of attributable capacity implies a value of Rs38/share.
Firm off-take arrangements and fuel pass-through offset specific macro risks
LITL has a project portfolio of 7,234 MW, of which 4,686 MW is to be sold under firm off-take
arrangements with fuel cost pass-through, thereby insulating the earnings of the company from
macro headwinds on merchant rates and rising prices of fuel (though availability can still be
questioned). We note that LITL’s portfolio is well-diversified with 32% of sustainable capacities
dependent on merchant sale and dependence on domestic coal linkages restricted to 47%. In the
subsequent section, we discuss key investor concerns and recent macro problems and argue that
LITL is relatively better-positioned than peers.
Reiterate BUY with a revised target price of Rs65/share
We reiterate our BUY rating with a revised target price of Rs65/share (previously Rs80/share). The
upside risk to our target price emanates from improved visibility on planned projects that could
add another Rs9/share to our target price. Our SOTP-based target price now comprises—(1) DCFequity of power project portfolio at Rs51/share, and (2) construction business valued at Rs15/share
at EV/EBITDA of 5X on FY2012E. We have reduced our EPS estimates to Rs3.1/share in FY2011E
(previously Rs3.6/share) as we adjust for (1) lower merchant realization, (2) change in depreciation
policy and (3) commissioning delays.
Change in depreciation policy distorts earnings; also results in higher tax payout
LITL retrospectively changed its depreciation policy to SLM for all thermal projects
commissioned post FY2010 (previously WDV method) in 3QFY11. This change reversed a
policy change effected earlier in 4QFY10 when LITL shifted to WDV from SLM. In our view,
this shift would only lead to marginal value erosion (on account of higher tax outgo) and the
sharp correction in stock price offers an attractive buying opportunity.
Recent concerns on macro issues—likely overplayed for LITL
In our view, LITL, with its diversified portfolio in terms of fuel and sales mix, is relatively
better positioned than other utilities. The recent underperformance appears to be a result of
macro problems impacting the sector (1) availability and pricing of fuels, (2) softening
merchant tariffs, and (3) tightening monetary policy that could constrain availability and
pricing of funds. We discuss below in detail these issues and LITL’s positioning with respect
to the same.
Share of merchant sales—32% of sustainable capacity
Of 7,234 MW of a power portfolio, only 2,284 MW is being/or will likely be sold through
the merchant market, which insulates the balance portfolio from the risk of rising fuel cost
and/or softening rates of merchant tariff. We concede that the pace of decline (the direction
was something everyone agreed upon) in merchant tariffs has been surprising, we do not
see a significant risk to our sustainable realization assumption of Rs3.5/kwh. Exhibit 2
highlights the sale mix of LITL’s overall portfolio.
Short-term merchant tariffs in the bilateral market has averaged Rs4/kwh in October and
November 2010, and rate at the exchange and UI market had been even lower, raising
concerns on the Street’s expectations for merchant tariffs. However, recent trends in the
price of power traded through exchange and forward curve for bilateral trade already
indicate a revival in merchant tariffs and we expect further improvement going into the
summer months and as selective states prepare for assembly elections. We note that the
price of power traded on IEX is currently around Rs3.7/kwh while the forward curve for
bilateral trade indicate Rs4.57/kwh in bilateral market in April (see Exhibits 3 and 4).
Fuel—pass-through arrangements offset pricing risks
Of 2,082 MW in operational capacities, only 666 MW sell power on a merchant basis
comprising 300 MW coal-based capacity at Amarkantak and 366 MW gas-based capacity at
Kondapalli. Further, LITL’s entire portfolio of projects (including under-construction projects)
includes gas-based capacities (854 MW) and hydro capacities (740 MW). Dependence on
imported coal is limited to the Udupi projects (1,200 MW) and of the balance 3,440 MW
dependent on linkages from CIL—only ~1,300 MW does not have a pass-through of fuel
cost.
We note that the availability of fuel from Coal India, given the large deficit over
commitments, is not a company-specific issue and will likely affect power utilities at large,
increasing the dependence on imports. However, having a dominant share of its off-take
with fuel pass-through arrangements limits the downside to earnings. The recent acquisition
of Griffin Coal is a step in the right direction as it enhances the developer’s control over
pricing and availability of coal and reduces LITL’s dependence on CIL.
We concede that akin to coal, availability of gas is also a concern for all gas-based projects.
However, we highlight that LITL’s operational gas-based capacities of 854 MW have a firm
supply agreement and have faced limited supply constraints allowing them to operate at
PLFs of ~68% (Aban) to ~87% (Kondapalli) in FY2010. We currently ascribe a value of
Rs3/share to operational gas-based capacities of LITL.
High leverage—typical to large power projects
LITL had a consolidated net debt of Rs74 bn (excluding associates) as of March 2010
implying a net debt to equity of 2.2X. We estimate LITL’s net debt to rise to Rs143 bn by
end-FY2011E (including Anpara and Udupi debt) implying a net debt to equity of 3.4X—
typical of power companies which raise project level debt at 3X equity infusion. In our view,
the acquisition of Griffin Coal could further strain the balance sheet (depending on structure
of payments) as it would involve an additional debt of ~Rs24 bn (assuming a 70:30 debt
equity) and a capex of ~Rs40 bn for ramping up the production of coal mines.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Lanco Infratech (65)
Utilities
Excessively flayed over macro concerns. Lanco Infratech has underperformed the
broader market by 32% and our utility coverage universe by 26% (last three months)
on macro concerns surrounding (1) softening merchant tariffs, and (2) availability and
pricing of fuel, further compounded by the company’s frequent changes in accounting
policies. In our view, the CMP sufficiently factors the risks to earnings from macro
issues. We reiterate our BUY rating with a revised target price of Rs65/share.
Stress-case assumptions also suggest upside from CMP
LITL has underperformed the BSE-30 index by 32% in the past three months as frequent shuffling
of depreciation policy (along with general macro headwinds for the sector) has rattled investor
sentiment. Even if we adjust for lower plant load factors, the potential upside is significant. To
illustrate: A reduction by 15% due to constrained coal availability and reduction in sustainable
merchant tariffs would give Rs3/kwh (our base-case assumption is Rs3.5/kwh), the implied value of
Rs45/share would therefore offer 18% upside to the CMP. Alternatively, a modest 1.5X P/B
(assuming regulated cost-plus returns) on the already invested equity of Rs61 bn (Rs25/share) for
7,900 MW of attributable capacity implies a value of Rs38/share.
Firm off-take arrangements and fuel pass-through offset specific macro risks
LITL has a project portfolio of 7,234 MW, of which 4,686 MW is to be sold under firm off-take
arrangements with fuel cost pass-through, thereby insulating the earnings of the company from
macro headwinds on merchant rates and rising prices of fuel (though availability can still be
questioned). We note that LITL’s portfolio is well-diversified with 32% of sustainable capacities
dependent on merchant sale and dependence on domestic coal linkages restricted to 47%. In the
subsequent section, we discuss key investor concerns and recent macro problems and argue that
LITL is relatively better-positioned than peers.
Reiterate BUY with a revised target price of Rs65/share
We reiterate our BUY rating with a revised target price of Rs65/share (previously Rs80/share). The
upside risk to our target price emanates from improved visibility on planned projects that could
add another Rs9/share to our target price. Our SOTP-based target price now comprises—(1) DCFequity of power project portfolio at Rs51/share, and (2) construction business valued at Rs15/share
at EV/EBITDA of 5X on FY2012E. We have reduced our EPS estimates to Rs3.1/share in FY2011E
(previously Rs3.6/share) as we adjust for (1) lower merchant realization, (2) change in depreciation
policy and (3) commissioning delays.
Change in depreciation policy distorts earnings; also results in higher tax payout
LITL retrospectively changed its depreciation policy to SLM for all thermal projects
commissioned post FY2010 (previously WDV method) in 3QFY11. This change reversed a
policy change effected earlier in 4QFY10 when LITL shifted to WDV from SLM. In our view,
this shift would only lead to marginal value erosion (on account of higher tax outgo) and the
sharp correction in stock price offers an attractive buying opportunity.
Recent concerns on macro issues—likely overplayed for LITL
In our view, LITL, with its diversified portfolio in terms of fuel and sales mix, is relatively
better positioned than other utilities. The recent underperformance appears to be a result of
macro problems impacting the sector (1) availability and pricing of fuels, (2) softening
merchant tariffs, and (3) tightening monetary policy that could constrain availability and
pricing of funds. We discuss below in detail these issues and LITL’s positioning with respect
to the same.
Share of merchant sales—32% of sustainable capacity
Of 7,234 MW of a power portfolio, only 2,284 MW is being/or will likely be sold through
the merchant market, which insulates the balance portfolio from the risk of rising fuel cost
and/or softening rates of merchant tariff. We concede that the pace of decline (the direction
was something everyone agreed upon) in merchant tariffs has been surprising, we do not
see a significant risk to our sustainable realization assumption of Rs3.5/kwh. Exhibit 2
highlights the sale mix of LITL’s overall portfolio.
Short-term merchant tariffs in the bilateral market has averaged Rs4/kwh in October and
November 2010, and rate at the exchange and UI market had been even lower, raising
concerns on the Street’s expectations for merchant tariffs. However, recent trends in the
price of power traded through exchange and forward curve for bilateral trade already
indicate a revival in merchant tariffs and we expect further improvement going into the
summer months and as selective states prepare for assembly elections. We note that the
price of power traded on IEX is currently around Rs3.7/kwh while the forward curve for
bilateral trade indicate Rs4.57/kwh in bilateral market in April (see Exhibits 3 and 4).
Fuel—pass-through arrangements offset pricing risks
Of 2,082 MW in operational capacities, only 666 MW sell power on a merchant basis
comprising 300 MW coal-based capacity at Amarkantak and 366 MW gas-based capacity at
Kondapalli. Further, LITL’s entire portfolio of projects (including under-construction projects)
includes gas-based capacities (854 MW) and hydro capacities (740 MW). Dependence on
imported coal is limited to the Udupi projects (1,200 MW) and of the balance 3,440 MW
dependent on linkages from CIL—only ~1,300 MW does not have a pass-through of fuel
cost.
We note that the availability of fuel from Coal India, given the large deficit over
commitments, is not a company-specific issue and will likely affect power utilities at large,
increasing the dependence on imports. However, having a dominant share of its off-take
with fuel pass-through arrangements limits the downside to earnings. The recent acquisition
of Griffin Coal is a step in the right direction as it enhances the developer’s control over
pricing and availability of coal and reduces LITL’s dependence on CIL.
We concede that akin to coal, availability of gas is also a concern for all gas-based projects.
However, we highlight that LITL’s operational gas-based capacities of 854 MW have a firm
supply agreement and have faced limited supply constraints allowing them to operate at
PLFs of ~68% (Aban) to ~87% (Kondapalli) in FY2010. We currently ascribe a value of
Rs3/share to operational gas-based capacities of LITL.
High leverage—typical to large power projects
LITL had a consolidated net debt of Rs74 bn (excluding associates) as of March 2010
implying a net debt to equity of 2.2X. We estimate LITL’s net debt to rise to Rs143 bn by
end-FY2011E (including Anpara and Udupi debt) implying a net debt to equity of 3.4X—
typical of power companies which raise project level debt at 3X equity infusion. In our view,
the acquisition of Griffin Coal could further strain the balance sheet (depending on structure
of payments) as it would involve an additional debt of ~Rs24 bn (assuming a 70:30 debt
equity) and a capex of ~Rs40 bn for ramping up the production of coal mines.
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