Lanco (LITL) : Valuation offers comfort, capacity addition looks up :Motilal Oswal

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Valuation offers comfort, capacity addition looks up
Fuel, PPA uncertainties remain; funding requirement high
Lanco Infratech (LITL) is set to increase capacity from 3.3GW to 5.3GW by FY14, but
earnings growth faces headwinds like evacuation infrastructure, fuel security and PPA
issues. Higher leverage (~4.5x in March 2011) and funding requirements (Rs16b-18b over
FY12-14) are other near term operational challenges. However, the stock's correction
discounts concerns and we estimate earnings CAGR of 37% over FY11-13. We initiate
coverage with a Buy rating and a target price of Rs55.
Capacity addition looks up but fuel/PPA uncertainties remain
Lanco Infratech's (LITL) operating capacity will rise from 3.3GW to 5.3GW by FY14
as it commissions new units. However, LITL faces PPA issues for Unit-2 at Amarkantak,
and the lack of transmission line and fuel security have imapcted returns on its capacity
at Udupi (600MW) and Anpara (1.2GW). Merchant capacity is exposed to fuel
availability/cost risks and its Unit-2 at Amarkantak faces a tariff cap of Rs2.34/unit,
which is under contesting. LITL recently acquired stake in Griffin Mines with a view to
fulfilling its long term fuel requirements but the benefits are unlikely before FY13/Y14.
EPC business: Captive in-house business offers equity cash flow
A robust in-house project pipeline and large third-party contracts contributed to LITL's
Engineering, Procurement and Construction (EPC) division's order book, which was
Rs301b in March 2011. More than half of this is from three large in-house projects.
The in-house power segment contributes ~70% of LITL's outstanding order book.
However, we expect moderation even as it provides LITL with strong upfront cash flow.
Capacity addition leads earnings growth
LITL will post consolidated PAT of 37% CAGR over FY11-13, and the power sector will
account for over 80% of earnings in FY12 and FY13. We expect a decline in the
contribution of merchant earnings to total PAT, as we assume Amarkantak-I on a
regulated returns basis from mid-FY12. We expect LITL's operating cash flow to be
sustained at over Rs30b a year and DER is unlikely to taper off in the near term, as
debt for new projects is added. We have not assumed consolidation/contribution from
Griffin Mines, given lack of clarity on their operational/financial details.
Valuations offer comfort, initiating coverage with a Buy, target price: Rs55
LITL's stock has corrected by 60% over the past 12 months (relative under-performance
of 54%), due to a lack of clarity on PPAs, fuel security issues, accounting policy
changes, higher gearing and funding issues. Although these concerns have not all
receded, a price correction has largely discounted them. Our estimates are based on
a conservative stance on various issues/operating rates and so we believe current
valuations offer comfort. We initiate coverage with a Buy rating and a target price of
Rs55.