Lanco Infratech: Buy

Beaten down valuations and the company's recent acquisition of coal assets abroad make the stock attractive.

With its power generation capacities expected to double over the next couple of years, and capability to execute projects on time thanks to in-house EPC (Engineering, Procurement and Construction) expertise, Lanco Infratech is among the preferred investment options in the utilityspace.

Lanco has been able to reduce delays in execution compared with other players. Beaten down valuations and the company's recent acquisition of coal assets abroad make a compelling case for fresh investments in the stock. We reiterate a ‘buy' on this stock with a two-year time horizon. The stock has under-performed the CNX 500 index by 25 percentage points since our previous buy.

Power stocks inclusive of Lanco have witnessed a correction on the back of falling load factors, rising interest rates and moderating short-term merchant power tariffs. Fear of high leverage stretching the balance sheet has also taken its toll on Lanco. Yet, Lanco may come out of these issues unscathed as it has a judicious mix of long-term and short-term power purchase agreements reducing the off-take risk. It has also reduced the fuel risk by investing in high-quality mines abroad and is planning to raise external borrowings at a lower cost to fund its growth plans in the current rising interest rate scenario.

While the company has previously made it clear that existing equity would be sufficient for the near-to-medium term, after the current acquisition of coal assets, it may have to revisit equity to fund projects at an early stage of construction. At the current price of Rs 48, the stock seems to be one of the cheapest among the utilities at a price-book valuation multiple of 2.25 times its estimated FY12 book value. Strong growth in earnings, coupled with the fact that the profitability ratio is set to improve, may justify a valuation premium. The estimated PEM for FY-12 works out to 10.8 times. It has already achieved financial closure for projects with 4,034 MW capacity. However, the debt equity ratio of 3:1 as of September 2010 looks a little stretched.

Lanco's EPC business too is gaining steady momentum with third-party order inflows in addition to the in-house project expansion. In the current fiscal, it already won EPC contracts from Moserbaer and Mahagenco. The December quarter may see some moderation in earnings growth of Lanco as merchant power tariffs have softened. With summer fast approaching and Assembly elections in five states, merchant tariffs may once again firm up going forward.

Lanco is currently operating around 2,680 MW of projects with almost quarter of the capacities relying on merchant power. Of the 6,629 MW projects under construction, Lanco may implement another 675 MW of projects in the current fiscal and 1,342 MW over the next fiscal. On the fuel side, the newly acquired Griffin coal mine has a current production capacity of 4 mptaand Lanco plans to ramp up the capacity to 15 mtpa. This acquisition also benefits from rising coal spot prices which would aid earnings . The coal mines have total resources of over 1.1 billion tonnes.

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