Lanco Infratech - Merchant dilemma.- Kotak Sec

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Lanco Infratech (LANCI)
Utilities
Merchant dilemma. Lanco Infratech (LITL) reported a 43% yoy decline in net income
on account of (1) weak merchant tariffs, (2) scheduling problems at Amarkantak and
Kondapalli, and (3) declining construction margins. We note that the sharp weakness in
realizations during the quarter may be an aberration, though we maintain our
conservative stance on the sustainability of lucrative merchant tariffs. We maintain our
BUY rating with a target price of Rs80/share.





Weakness in short-term tariffs weighs on earnings
LITL reported consolidated revenues of Rs20.4 bn, operating profit of Rs4.2 bn and net income of
Rs705 mn against our estimate of Rs22.7 bn, Rs6.6 bn and Rs2.4 bn, respectively. Lower-thanestimated
revenues were primarily on account of (1) lower merchant realization at both Kondapalli
and Amarkantak and (2) larger contribution of construction revenues from project subsidiaries.
Revenues met estimates on account of low margin power trading business, resulting in a further
dilution of margins from the power business. EBIT margins in the construction business declined
sequentially by 500 bps on account of a delay in final-leg payment for Udupi project, which is yet
to be capitalized.

Low realizations may be an aberration, but remain cautious on sustenance in the long-term
LITL’s merchant realizations took a hit for both Kondapalli and Amarkantak plants. Kondapalli sold
516 MU in short-term market at an average rate of Rs4.3/kwh (Rs6.15/kwh in 1QFY11) and
Amarkantak sold 411 MU at an average rate of Rs3.8/kwh. Management has indicated that owing
to synchronization activities at Kondapalli, a bulk of the power had to be sold through exchange,
fetching lower realizations. For Amarkantak, most of the power had to be sold through very shortterm
PPAs (yielding lower tariffs) as the plant had taken its annual maintenance shutdown during
the month of August.

We discuss below in detail the dynamics of merchant tariffs in 2QFY11 and conclude that the
weakness is not attributable to a structural shift driven by oversupply but largely driven by demand
de-growth in 2QFY11. We therefore remain optimistic that short-term rates would strengthen post
the monsoons, though we would watch closely whether the current premium enjoyed by
merchant tariffs sustains.

Retain BUY rating with a revised target price of Rs80/share
We retain our BUY rating with a revised target price of Rs80/share. Upside risk to our target price
emanates from improved visibility on planned projects that could add another Rs9/share to our
target price.

We note that LITL will likely sell only 17% of its overall portfolio (post commissioning of Udupi
and Anpara) through short-term contracts.