Lanco Infratech

Investors with high risk appetite can consider fresh exposure to the stock of Lanco Infratech with a two-year investment horizon. The company plans to add 1888 MW of additional capacity, trebling its capacity in FY11 which will significantly boost its earnings. It has already commissioned 733 MW of power projects in the June quarter of this fiscal, taking the current operating capacity to 2082 MW.



Interestingly, the company had only a 511 MW project as of March 31 2009.

While the scaling up of capacity led to re-rating, the stock may give better returns as it enters the big league of power utilities. The potential upside to the stock from here would be determined by its on-time execution capabilities for bigger projects, short-term power tariffs and financial closure of residual projects under construction.

At current market price of Rs 66, the stock is discounting its FY12 earnings by 14 times and 2.7 times its estimated FY12 book value. In terms of book value multiple, only public sector peers with regulated margins are at a discount to Lanco making it one of the cheaper stocks in the power sector.

Lanco will immensely benefit from the current short-term tariffs as against the future projects when the merchant rates are expected to soften. Despite the earnings moderation in other revenue segments such as EPC (engineering, procurement and construction), real estate and accounting change done in depreciation, the stock will continue to have strong profit growth.

Business

Lanco Infratech is an integrated infrastructure player with presence in power, other infra segments, power trading and real estate. A significant proportion of its revenues comes from EPC/construction and power generation followed by power trading.

In-house EPC tends to reduce execution risk and sustainable revenue stream for the company when the capital is still locked up during the construction stages. Earnings from EPC (inclusive of internal accruals from power) can be used for funding the equity portion of other projects.

The capacity of power projects is set to jump from 2082 MW (which include the recently commissioned Lanco Kondapalli unit of 133 MW and the Udipi unit of 600 MW) to 3970 MW over the next one year and capacity will go up to 9300 MW by end-2014. It has another 2500 MW in planning stages.

In terms of fuel mix the company has moved from gas projects to coal projects which have better fuel availability. The company is also executing relatively bigger hydro projects. The fuel mix by 2014 would be 74 per cent coal, 8 per cent hydro and 18 per cent gas.

Lanco has around 666 MW (Amarkantak-1 and Kondapalli Ph II) of merchant capacities currently. This proportion is set to go up as the company structured its off-take with part power purchase agreements (PPAs) for most of the projects.

This judicious mix of purchase agreements enable it to earn higher returns (around 25 per cent) while reducing the off-take risk to some extent. The company has signed most of the PPAs with fuel as a pass-through component, to reduce fuel price volatility. Only the Udupi project is running on imported coal while the other coal-based projects either have coal linkages or captive coal blocks.

Funding

Of the 7229 MW under construction, 2700 MW of projects are in advanced stages of completion. Around 2600 MW of project have attained financial closure with the management expecting financial closure of bigger projects in the first half of this fiscal. While more than Rs 35,000 crore capex in pipeline, equity funding of more than Rs 8,000 crore seems very high.

The company last year raised Rs 723 crore through a QIP for funding the near-term projects. Internal accruals over the next four years would take care of most of the equity funding for the company. The debt-equity ratio of the company stood at 2.5 as of March 31 2010, down from 4 the preceding year.

Financials

The consolidated net profits have grown at 28 per cent annual rate over the last four years with higher contribution from the EPC segment. Currently, EPC and construction contribute 55 per cent of the sales and 61 per cent of EBIDTA. However, power generation, which contributes 38 per cent to EBIDTA, is all set to grow manifold. As of March 31, 2010, the EPC and construction segments have an order book of around Rs 25,700 crore.

However, barring the projects nearing completion, the rest are in the initial stages of construction which may mean volatile revenue flow from this segment.

Lanco Infratech's trading arm continues to contribute to short-term trading volumes allowing an additional income stream for the company. In addition, carbon credits for some of its gas-based and alternative-energy projects contribute marginally to the earnings. As of March 31, 2010, the EBIDTA margin of the EPC segment was 14.7 per cent which may moderate to industry levels of 10-11 per cent as more projects outside of the power sector are taken up.

Risks

Additional cess on coal and hike in MAT rate are key negatives for Lanco which are already priced-in. The company is using Chinese equipments which are not tested for Indian coal.

Given the high leverage of the company, any adverse movements in interest rate would increase the interest costs for the company.