Lanco Infratech - For the long haul

Lanco Infratech is in the business of construction, power generation and real estate. The company’s IPO, which opens today, is priced in a band of Rs 200-240 for an equity share of Rs 10 each with an issue size of Rs 890-1,067 crore at the two ends. The proceeds of the issue are to be used for the company’s upcoming power and property projects and for acquiring additional equity in existing plant.

Fund usage will be to the tune of Rs 642 crore in 1,015 mw Nagarjuna power plant, Rs 256 crore in 600-mw Amarkantak project and the rest for other projects. With the current projects on hand and expected earnings over the next five years, the stock holds sufficient value.

However, since most of its projects are expected to go on stream line beginning ’09, the issue may be looked at as long-term investment only. The company is undertaking several projects in various areas, with construction being its core business.

In the power sector, Lanco Infratech has a current operating capacity of 509 mw, of which 488 mw is generated from two gas-based plants. It expects to commission 690 mw of capacity in FY09 and 1,690 mw of capacity in FY10.

Of these, about 675 mw will come from hydro and 1,615 mw from two coal-based plants. This is apart from the 1,000-mw Anpara project, for which it recently won the bid, as well as the memorandum of understanding (MoU) with the Orissa government for 1,320 mw, which is at a very early stage.

The power plants are being developed through various joint ventures, which help to mitigate the risks, as well as bring in outside expertise. Of the total project, financial closure was achieved for about 1,200 mw of capacity.

In the power business, financial closure is an important milestone as tariff (or selling price) is determined as per the guidelines of regulatory authority and the off-take risk is relatively low.

While the tariff is fixed so as to provide a 14% return on equity, there is an upside to it, which comes with more than 80% plant load factor (equivalent to capacity utilisation).

However, the running plant at Kondapalli (368 mw) is at a disadvantage due to shortage of gas and had a PLF of only 67.2% in FY06. Although the fixed costs are reimbursed as per the contracts, gas shortage eliminates the upside in earnings.
In construction, it aims to generate significant revenue from in-house power projects apart from outside projects. Construction accounts for 35% and 60% of the cost in coal and hydro projects, respectively. It currently has about Rs 1,200 crore worth of projects on hand and can generate a total revenue of about Rs 4,000 crore till FY10 (apart from the Anpara project).

The company is also actively participating in the development of real estate in Hyderabad, where growth is being led by the boom in the information technology industry. It is expected to meet about 5% of commercial space demand and 7-8% of residential demand in the city over the next few years.

It owns or has won bids to develop 19.5 million square feet of saleable area, including a 100-acre IT park in Hyderabad. Due to the ongoing boom in the industry, there is significant upside in this area of business.

Since the proceeds of the IPO will go towards long-term projects, it will be incorrect to judge it on the basis of current P/E, which runs at about 200 times. Earnings should begin to flow from FY09 and stabilise by FY11.

The P/E, based on FY10 earnings, comes to around 4.0 times for the consolidated business. In comparison, estimates for power companies range at around 13 and for existing construction companies, it is about 8 times.

Based on the estimates and projections, there is sufficient value in the stock for long-term investors. However, there is an element of uncertainty with respect to project execution, funds mobilisation and regulatory environment, considering the longer horizon. Investors will have to keep a long-term view to realise the gains.