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With Lanco Infratech's stock crashing almost 80 per cent on the bourses in 2011, what should investors do? From a valuation perspective, the stock trades at 0.6 times its September-end consolidated book value of the company (at the current price of Rs 11) as against 1.2-2.4 times enjoyed by other private peers. KSK Energy, at 0.75 times the book value, trades at a premium to Lanco, which is among the top three private power generation companies today in terms of installed capacity.
However, the stock may have limited upside for now, given the high leverage, dependence on group companies for revenue and the overhang of the legal tussle with Perdaman. Investors with large exposures can reduce holdings and re-enter once clarity emerges on the above. The Perdaman trial is set to begin in the Australian courts in April 2012.
Apart from the above issues, the challenges dogging the power sector — tariff disputes between parties, rising fuel costs, faltering fuel supplies and execution delays due to external factors also cloud Lanco's prospects.
BUSINESS
Lanco is an Engineering Procurement and Construction player. It houses all its power projects in subsidiary and associate companies. The EPC division significantly caters to the power subsidiaries' needs of building power plants. The use of in-house EPC capabilities allows Lanco to improve profit margins for the group as costs remain within its control. This also puts the execution of the project within its control.
However, the flip side of this is that fortunes of the EPC business are closely tied to the company's power projects. For the half-year ended September, income from group companies accounted for over half the revenues of the EPC business.Lanco is trying to diversify its order book by winning some external EPC orders such as Moser Baer Thermal Power Project and Koradi Thermal Project.
DEBT BURDEN
A key issue which continues to trouble Lanco is its high debt burden. As of September 2011, the company has a debt-to-equity ratio of 3.5 times at a consolidated level. Additionally, close to a quarter of the debt is foreign currency loan, subjecting the company to the adverse impact of rupee depreciation.. Much of the debt funds the power projects. Its installed capacity of 3892 MW, as of September 2011, is set to rise to 5300 MW by end of FY13.
Yet, capacity additions have not contributed fully to revenues due to low plant load factors and delays in going onstream.. For instance, the 600-MW Udupi unit-2 awaits completion of transmission evacuation infrastructure. The Kondapalli 3,742-MW gas-based project is yet to get gas supply allocation, which creates uncertainty in commercial production.
Such delays may depress return ratios and impact operating cash flows which are required to fund future investments. To tide over funding issues, the company plans to consolidate its power business currently under different subsidiaries into one entity and raise equity through private equity or public listing of its power business. However, such moves are feasible only after the equity market revives.
PERDAMAN ISSUE
The company may in future manage to reap benefits from firm merchant tariffs. However, the impact may be partly neutralised by low fixed tariffs for a few projects that have already tied themselves into power purchase agreements. Around a quarter of the current installed capacity of the company is based on merchant power.
Apart from the fuel and debt challenges that haunt the prospects of most of the power generation companies, Lanco also faces an additional challenge from its takeover of coal mining company — Griffin Coal. The move, fully debt-funded and intended to secure fuel linkages, gave Lanco access to an operational asset with production capacity of 4 million tonnes of coal per annum. The company was also to invest further to ramp up the capacity to 20 million tonnes per annum, which was expected to take care of its fuel requirement for upcoming coal-based projects. Post-acquisition, however, Perdaman, one of Griffin's earlier customers, took Lanco to court alleging that the company had reneged on a coal supply agreement.
What makes this development worrisome to investors is the size of the liability claimed by Perdaman. At Australian $ 3.5 billion, the size of lawsuit is close to 6 times the current market-capitalisation of the Lanco stock.
Griffin Coal has suffered losses of Rs 238 crore during the September quarter (inclusive of forex losses), an additional setback for Lanco, given the debt the company has taken to fund this project. What is more, both the coal production increases and the setting up of evacuation infrastructure at Griffin will entail further investments by Lanco. One positive development on this front, however, is Griffin's talks with Bluewater Power (the biggest customer for Griffin) over coal supplies which may allow for a nominal rise in coal prices, and improve realisations.
FINANCIALS
Lanco Infratech's September 2011 losses of Rs 259 crore at the consolidated level are partly the result of mark-to-market losses on foreign exchange loans that featured in many companies' financials in the latest quarter.
The management has, however, clarified that much of its foreign debt will not fall due in the short term and is repayable only after three years, alleviating any near-term pressure on cash flows. The company booked higher revenues from EPC business which witnessed a 73 per cent year-on-year jump for the quarter ended September.
Substantial revenue from group companies, changing depreciation policies and the change in the portfolio of subsidiaries, however, reduces comparability of the numbers from year-to-year and clouds the earnings picture for investors.
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