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UBS Investment Research
Lanco Infratech
C orrection a buy opportunity [EXTRACT]
We lower our price target from Rs70.00 to Rs30.00; maintain Buy rating
The share price has corrected 74% YTD and we think reflects the difficult
environment for the generation sector and company-specific issues. However, we
believe that the market is ignoring the strong generation capacity base (3,300MW),
which is not easy to replicate. We also believe that the share price fully factors in a
decline in merchant tariffs and the likely impact on Plant Load Factor (PLF) due to
non-availability of fuel. We maintain our Buy rating and lower our price target to
Rs30.00.
There are challenges as well
In the near term, we believe risks are as follows: 1) a court case related to Griffin
Coal in Australia; 2) transmission issues at the Udupi 1,200 MW plant; 3) lack of
clarity on the power purchase agreement (PPA) of 300MW; and 4) fuel issues at
operational plants. However, we think that most are short-term issues and are
priced in.
Lower FY12/FY13/FY14 EPS estimates 80%/57%/42%
We lower our FY12/FY13/FY14E EPS from Rs3.56/5.88/6.99 to Rs0.70/2.56/4.04
due to our lower PLF assumptions and higher elimination of inter-segmental
revenue. We lower our steady-state PLF forecast 500bp from 90% to 85% over the
medium and long term. We also increased our elimination of inter-segmental EPC
profits forecast from 20% to 60-80%.
Valuation: new price target of Rs30.00
We derive our price target from a sum-of-the-parts methodology. We value Lanco
as a conglomerate, with power contributing 81% of the valuation and EPC 13%
Lanco: the worst performer in the sector
Lanco’s share price has corrected 74% YTD and underperformed the BSE
Sensex 67% YTD. In our view, this was caused by company-specific issues as
well as negative sentiment on generation. The major factors are: 1) changes to
the accounting policy; 2) a lawsuit filed by Perdaman against Lanco in
Australia; 3) the EPC business dependence on power projects; and, 4) the
unpredictability of earnings.
Accounting policy changes
In Q1 FY11, the company changed its accounting policy to a diminishing value
basis but changed back to a straight-line method in Q3 FY11. The depreciation
periods remain unchanged. We think investors may be worried that the changes
mask a fundamental problem with the company. Our view is the change was
more a failure to fully think through the implication of the original accounting
policy change before implementation.
When it moved to a diminishing value method, management was trying to
reduce the political risks associated with very high returns when merchant
power prices were high by front-end loading depreciation. This made reported
earnings vulnerable when merchant power prices normalised in the second half
of 2010. We think the return to the original straight line method is appropriate
and brings the accounting policy back into line with industry practice.
Perdaman files a lawsuit against Lanco in Australia
In February 2011, Lanco acquired Griffin Coal of Australia for A$730m.
Perdaman’s urea plant (to be completed in FY15) in Western Australia was
expected to receive coal from Griffin’s mines. Perdaman is seeking damages of
A$3.5bn, as a watertight coal supply agreement has not been signed and
Perdaman claims Lanco is responsible. We checked the timeline of Perdaman’s
urea plant and it should be completed in December 2014. We believe that the
fuel requirement (from Griffin’s mines to Perdaman’s plant) will arise only after
the plant becomes operational. Apart from the fact that the court may ask Lanco
to supply coal as and when Perdaman’s urea plant is ready, we do not expect any
more adverse consequences for Lanco.
Table 1: Perdaman’s urea project timeline
Milestone Timeline
Public announcement of project March 2009
Commencing community consultation April 2009
Permitting and environmental approvals March 2009 -March 2010
Engineering June 2009-January 2012 (95% completion)
Construction contract arrangements finalised February 2010
Financial close Q211
Field construction start Q311
Mechanical completion Q413
Start-up begins Q114
Full production Q414
Source: Company data
Based on information from Perdaman’s website, we note that the basic raw
material agreement for coal is with Griffin, as the website mentions that
Perdaman signed a 25-year contract with Griffin to supply coal from the Collie
Mine. This may mean the contract has not yet been terminated.
EPC business is dependent on power projects
As of 30 June 2011, Lanco’s EPC order book stood at Rs310bn. For Q1 FY12,
the company reported order inflow of Rs25bn. The contribution of powerrelated
orders was c90% and other orders are for roads, buildings and industrial
projects. Internal orders (for Lanco’s power projects) contributed 75% of the
order book. This is an area of concern for many investors.
If there is slower-than-expected progress on the power projects, there will be
negative impacts due to: 1) investment in the stalled power project will not
produce returns; 2) liability will be incurred on the debt; 3) advance orders to
external vendors; and 3) EPC revenue would be affected, which would impact
overall earnings.
Reported earnings are unpredictable
Lanco reported a sharp decline in Q1 FY12 PAT and operating income declined
8% YoY to Rs19.49bn due to the higher elimination of inter-segment sales
(Rs11.46bn in Q1 FY12 versus Rs4.25bn in Q1 FY11). EBITDA declined 18%
YoY to Rs4.91bn on higher staff costs and overhead expenses. Reported PAT
declined 93% YoY to Rs138m. The reported PAT is after the elimination of
Rs2.21bn of profits from transactions with subsidiaries and associates.
The fact that the elimination of profits from transactions with subsidiaries and
associates has such a drastic impact on earnings on a reported basis is also a
point of concern for investors. However, we believe the concern is overstated, as
reported earnings do not necessarily reflect cash earnings or the overall health of
the business.
We also think that once the market stabilises, Lanco may revive its plan to list
the power subsidiary separately. This should help improve the transparency of
earnings at the power business, which we think is the core business of Lanco.
This would be a key positive change, in our view.
We lower FY12/FY13/FY14E EPS 80%/57%/42%
We lower our FY12/FY13/FY14E EPS from Rs3.56/5.88/6.99 to
Rs0.70/2.56/4.04 due to our lower PLF assumptions and higher elimination of
inter-segmental revenue. We lower our steady-state PLF forecast 500bp from
90% to 85% over the medium and long term. We also increase our elimination
of inter-segmental EPC profits forecast from 20% to 60-80%.
Valuation
In the near term, we believe the risks for the company are as follows: 1) the
court case with Griffin Coal in Australia; 2) transmission-related issues at the
Udupi 1,200MW plant; 3) lack of clarity on the PPA of 300MW; and 4) fuel
issues at operational plants. However, we think most are short-term issues. We
believe Lanco will be a key beneficiary of a pick-up in the generation sector,
and we note that the shares are currently trading close to the bottom of the
historical trading range.
The key changes are: 1) power assets (we lower PLF from 90% to 85% and we
assume a delay in commissioning of six to nine months); 2) the EPC business
(lower revenue growth forecast from 30% to 15% due to an increase in
attributable debt from Rs12bn to Rs20bn; 3) zero contribution from real estate
due to the slow down in the property market; 4) we apply a 50% discount to the
valuation of road projects; and 5) we increase the discount rate from 13.6% to
15.8% by increasing the equity-risk premium (from 5.5% to 7.5%), and we
increase our risk-free rate from 8.1% to 8.3%.
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
Risks include: failure to procure coal for existing or future power plants;
inability to fully recover changes in coal prices; slow or non-collection of
accounts receivables; difficulties in securing bank or other funding for
development projects; and lower-than-expected merchant power prices.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Lanco Infratech
C orrection a buy opportunity [EXTRACT]
We lower our price target from Rs70.00 to Rs30.00; maintain Buy rating
The share price has corrected 74% YTD and we think reflects the difficult
environment for the generation sector and company-specific issues. However, we
believe that the market is ignoring the strong generation capacity base (3,300MW),
which is not easy to replicate. We also believe that the share price fully factors in a
decline in merchant tariffs and the likely impact on Plant Load Factor (PLF) due to
non-availability of fuel. We maintain our Buy rating and lower our price target to
Rs30.00.
There are challenges as well
In the near term, we believe risks are as follows: 1) a court case related to Griffin
Coal in Australia; 2) transmission issues at the Udupi 1,200 MW plant; 3) lack of
clarity on the power purchase agreement (PPA) of 300MW; and 4) fuel issues at
operational plants. However, we think that most are short-term issues and are
priced in.
Lower FY12/FY13/FY14 EPS estimates 80%/57%/42%
We lower our FY12/FY13/FY14E EPS from Rs3.56/5.88/6.99 to Rs0.70/2.56/4.04
due to our lower PLF assumptions and higher elimination of inter-segmental
revenue. We lower our steady-state PLF forecast 500bp from 90% to 85% over the
medium and long term. We also increased our elimination of inter-segmental EPC
profits forecast from 20% to 60-80%.
Valuation: new price target of Rs30.00
We derive our price target from a sum-of-the-parts methodology. We value Lanco
as a conglomerate, with power contributing 81% of the valuation and EPC 13%
Lanco: the worst performer in the sector
Lanco’s share price has corrected 74% YTD and underperformed the BSE
Sensex 67% YTD. In our view, this was caused by company-specific issues as
well as negative sentiment on generation. The major factors are: 1) changes to
the accounting policy; 2) a lawsuit filed by Perdaman against Lanco in
Australia; 3) the EPC business dependence on power projects; and, 4) the
unpredictability of earnings.
Accounting policy changes
In Q1 FY11, the company changed its accounting policy to a diminishing value
basis but changed back to a straight-line method in Q3 FY11. The depreciation
periods remain unchanged. We think investors may be worried that the changes
mask a fundamental problem with the company. Our view is the change was
more a failure to fully think through the implication of the original accounting
policy change before implementation.
When it moved to a diminishing value method, management was trying to
reduce the political risks associated with very high returns when merchant
power prices were high by front-end loading depreciation. This made reported
earnings vulnerable when merchant power prices normalised in the second half
of 2010. We think the return to the original straight line method is appropriate
and brings the accounting policy back into line with industry practice.
Perdaman files a lawsuit against Lanco in Australia
In February 2011, Lanco acquired Griffin Coal of Australia for A$730m.
Perdaman’s urea plant (to be completed in FY15) in Western Australia was
expected to receive coal from Griffin’s mines. Perdaman is seeking damages of
A$3.5bn, as a watertight coal supply agreement has not been signed and
Perdaman claims Lanco is responsible. We checked the timeline of Perdaman’s
urea plant and it should be completed in December 2014. We believe that the
fuel requirement (from Griffin’s mines to Perdaman’s plant) will arise only after
the plant becomes operational. Apart from the fact that the court may ask Lanco
to supply coal as and when Perdaman’s urea plant is ready, we do not expect any
more adverse consequences for Lanco.
Table 1: Perdaman’s urea project timeline
Milestone Timeline
Public announcement of project March 2009
Commencing community consultation April 2009
Permitting and environmental approvals March 2009 -March 2010
Engineering June 2009-January 2012 (95% completion)
Construction contract arrangements finalised February 2010
Financial close Q211
Field construction start Q311
Mechanical completion Q413
Start-up begins Q114
Full production Q414
Source: Company data
Based on information from Perdaman’s website, we note that the basic raw
material agreement for coal is with Griffin, as the website mentions that
Perdaman signed a 25-year contract with Griffin to supply coal from the Collie
Mine. This may mean the contract has not yet been terminated.
EPC business is dependent on power projects
As of 30 June 2011, Lanco’s EPC order book stood at Rs310bn. For Q1 FY12,
the company reported order inflow of Rs25bn. The contribution of powerrelated
orders was c90% and other orders are for roads, buildings and industrial
projects. Internal orders (for Lanco’s power projects) contributed 75% of the
order book. This is an area of concern for many investors.
If there is slower-than-expected progress on the power projects, there will be
negative impacts due to: 1) investment in the stalled power project will not
produce returns; 2) liability will be incurred on the debt; 3) advance orders to
external vendors; and 3) EPC revenue would be affected, which would impact
overall earnings.
Reported earnings are unpredictable
Lanco reported a sharp decline in Q1 FY12 PAT and operating income declined
8% YoY to Rs19.49bn due to the higher elimination of inter-segment sales
(Rs11.46bn in Q1 FY12 versus Rs4.25bn in Q1 FY11). EBITDA declined 18%
YoY to Rs4.91bn on higher staff costs and overhead expenses. Reported PAT
declined 93% YoY to Rs138m. The reported PAT is after the elimination of
Rs2.21bn of profits from transactions with subsidiaries and associates.
The fact that the elimination of profits from transactions with subsidiaries and
associates has such a drastic impact on earnings on a reported basis is also a
point of concern for investors. However, we believe the concern is overstated, as
reported earnings do not necessarily reflect cash earnings or the overall health of
the business.
We also think that once the market stabilises, Lanco may revive its plan to list
the power subsidiary separately. This should help improve the transparency of
earnings at the power business, which we think is the core business of Lanco.
This would be a key positive change, in our view.
We lower FY12/FY13/FY14E EPS 80%/57%/42%
We lower our FY12/FY13/FY14E EPS from Rs3.56/5.88/6.99 to
Rs0.70/2.56/4.04 due to our lower PLF assumptions and higher elimination of
inter-segmental revenue. We lower our steady-state PLF forecast 500bp from
90% to 85% over the medium and long term. We also increase our elimination
of inter-segmental EPC profits forecast from 20% to 60-80%.
Valuation
In the near term, we believe the risks for the company are as follows: 1) the
court case with Griffin Coal in Australia; 2) transmission-related issues at the
Udupi 1,200MW plant; 3) lack of clarity on the PPA of 300MW; and 4) fuel
issues at operational plants. However, we think most are short-term issues. We
believe Lanco will be a key beneficiary of a pick-up in the generation sector,
and we note that the shares are currently trading close to the bottom of the
historical trading range.
The key changes are: 1) power assets (we lower PLF from 90% to 85% and we
assume a delay in commissioning of six to nine months); 2) the EPC business
(lower revenue growth forecast from 30% to 15% due to an increase in
attributable debt from Rs12bn to Rs20bn; 3) zero contribution from real estate
due to the slow down in the property market; 4) we apply a 50% discount to the
valuation of road projects; and 5) we increase the discount rate from 13.6% to
15.8% by increasing the equity-risk premium (from 5.5% to 7.5%), and we
increase our risk-free rate from 8.1% to 8.3%.
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
Risks include: failure to procure coal for existing or future power plants;
inability to fully recover changes in coal prices; slow or non-collection of
accounts receivables; difficulties in securing bank or other funding for
development projects; and lower-than-expected merchant power prices.
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