Stock Review: Lanco Infratech

 

The cash flow from Lanco Infra's power and construction biz will be crucial since it's going to be the main growth driver

   LANCO Infratech share has plummeted 43% in the past three months due to concerns over fuel availability and softening merchant tariffs. However, at current valuations, the company's stock factors in all these risks and provides a potential for upside. Investors can consider buying into the stock.

COMPANY & BUSINESS:

Lanco Infratech is an integrated infrastructure development company in India with presence in power; engineering, procurement and construction (EPC); roads and highways, and property development sectors through its various subsidiaries. Power business contributes around 55% to the company's total revenue, construction accounts for 43%, and the rest comes from property development. With over 93% of its capital expenditure incurred in the power business, the company's future performance will depend on this segment. By fiscal year 2014-15, it plans to increase capacity to 9,296 mw from 2,074 mw currently across 10 states. The company's EPC business has an orderbook of 27,520 crore. Of this, over 90% is from power business of Lanco itself. Among other projects, the company is developing around 440-km roads of national highway on a buildoperate-and-transfer basis.

FINANCIALS:

Compared to three years ago, Lanco's net profit has more than doubled to 652 crore and net sales have increased by almost four fold to 8,045 crore for the year ended December 2010, due to addition in power generation capacity. The company's aggressive capacity expansion plans are seen sustaining earnings growth, going forward.

   The company incurred a total capital expenditure of 17,891 crore as of December 2010, of which 16,670 crore was on power projects. The total capex includes debt of 11,271 crore, with debtto-equity ratio at 3.2. The company has a huge project pipeline of over 11,070 mw. The cash flow from its power and construction business is seen supporting its capacity expansion in a phased manner. But if the company decides to build all capacities simultaneously, equity dilution could be expected. The company's current EBIDTA margin is 29.6%. As the contribution from highmargin business of power generation grows, the company's operating profit margin is expected to expand in future. Return ratios of the company are fairly decent.

CONCERNS AND INVESTMENT RATIONALE:

Some of the biggest concerns for Lanco are softening merchant prices, fuel availability, and rising coal prices. Of the 2,074-mw power capacity currently operational, 666 mw or 32% is sold on merchant basis. The company plans to maintain this ratio even in future.

   The merchant tariff rates, which fell steeply towards the end of 2010, are back on an uptrend. Historical trends indicate that the bilateral rates would peak in summer and upcoming assembly elections in a few states support this assumption. In the case of fuel risks, only 45% of Lanco's total fuel required would be through domestic coal linkages. Considering Coal India's likely default on its commitment, the industry will face a similar problem. Of 7,222 mw of under construction capacity, 65% or 4,686 mw would be sold under off-take arrangements with fuel cost pass-through.

   The acquisition of Griffith coalmines was a step in the right direction securing more fuel supply. By fiscal year 2014-15, 23% of the total capacity would be dependent on gas (15%) and hydro (8%). Securing gas for gas-based projects is also a problem, but more than 60% of the gas supply is assured.

VALUATIONS:

The company's current valuation at EV/EBIDTA of 9.5, compared with 14.4 of JSW Energy and 44 of Adani Power, discounts all concerns and risks. The company's return-on-equity is 16.6%. Its price-to-earnings is 13.3, which is one of the lowest in the current year, the highest was 37. Adani Power is trading at 54 and JSW Energy at 12.9. These valuations provide upside potential with limited downside risks.