Friday, October 5, 2012

Lanco Infra - The Full Picture.

A holding company with a diversified basket of businesses in supposed to be an ideal to setup risk. But, on the flip side, the parent's illness can have a contagion effect, spreading to other companies in the group. Take for instance, Lanco Infratech, which acts as a holding company for several diverse businesses like power, natural resources, infrastructure and real estate. The stock has lost a whopping 86% from its five-year high of Rs 88 reported in December 2007 to the present level of Rs 12.3. It has shed over Rs 17500 crore in market capitalisation. Currently, the scrip commands market value of Rs 2850 crore.

The prime reason for the counter's decline is the hefty debt the company has accumulated over the years. Debt of Lanco Infratech rose more than 85% to Rs 22152.1 crore end March 2012 from a year earlier. The company's finance cost rose nearly 40% to 1053.8 crore in the financial year ended 31 March 2012 (FY 2012) from FY 2011. It plunged into red with loss of Rs 150.5 crore (adjusted PAT) in FY 2012 as against profit of Rs 449.5 crore in the previous year. The worse seems to be still ahead for its shareholders. Lanco Infratech's finance cost rose nearly 75% to Rs 538.9 crore in the first quarter ended 30 June 2012 over the previous-year period. The finance cost is around 15.4% of its total income from operations. This magnitude reveals the uphill task the company is staring at. It reported a massive loss of Rs 441.1 crore in the June 2012 quarter compared with profit of Rs 13.7 crore in the corresponding quarter of the previous year. This is despite 87.2% jump in the revenue in the June 2012 quarter. A massive increase in cost of material, which spurted by 150.7%, is one of the reasons for erosion in profit apart from higher interest outgo.

The second concern is supply of raw materials. Lanco Infratech has operational power generating capacity of 4,480 MW. Capacities under construction total 4,888 MW. These capacities were spread over 12 states end June 2012.
Coal India is still in the process of approving fuel supply agreements (FSA) with coal supply trigger of 80%. Whenever this happens, it would be positive development for the power sector. Intervention of the prime minister is likely to bear fruits. The FSA is mainly stuck due to lack of consensus over the issue of the clause pertaining to penalty in case of short supply. However the scenario on power supply would take its own sweet time to improve.
Lanco Infratech's Griffin coal mines have the largest operational thermal coal mines in Western Australia, with reserves of 1.2 billion tonnes. The company plans to increase production to 4-5 times 18 million tonnes per annum (mtpa) by FY 2018. However, this is another problem area. At present, Griffin is a loss venture. The Australian company reported negative earnings before interest tax depreciation and amortization (Ebitda) of Rs 73.6 crore. Lanco Infratech had acquired Griffin coal mines in FY 2011.

Further, short supply of gas from the Krishna Godavari (KG) basin of Reliance Industries is another bone of contention for Lanco Infratech. Decline in natural gas production from the KG has adversely impacted generation from its gas-based power plants. The company's Kondapalli power plant in near Vijayawada in Andhra Pradesh has reported lower plant load factor of 60% due to short supply of gas from KG basin in FY2012. Out of its aggregate power generation capacity of 1334 MW, around 30% is based on gas (Kondapalli 1,214 MW and Tanjore 120 MW). Going forward, Lanco Infratech may be forced to shut its gas-based power plants if supply of gas declines further. Fortunately for the company, out of the total power generating capacities of 4,888 MW, which will be commissioned over the next three years, only 252 MW is based on gas.
The third source of worry is the stagnant order book and choking up the receivables pipeline, resulting in liquidity crunch. Lanco Infratech's engineering, procurement and construction (EPC) division executes projects in areas of thermal and hydro power plants, highways, airports, industrial structures, transmission, distribution, chimneys and cooling towers, water infrastructure and heavy civil construction. The order book of its EPC division was at a robust US$6.1 billion end March 2012. There is no exciting growth in order book, which stood at US$6 billion end FY 2011, but still it is on the higher side. Apart from third-party orders, Lanco Infratech mainly executes order of its group companies including power plants.

The in-house orders have their own concerns. One of Lanco's subsidiaries and an associate had provided mobilisation advance of Rs 434.9 crore on 30 June 2012 for executing EPC contract, which requires approval by the respective lenders. Lanco Infratech has to receive Rs 395 crore as retention money from the subsidiary and associate. The concerned special purpose vehicle (SPV) has approached the lenders for release of the retention money against providing the corporate or bank guarantee by the company. The lender's approval is in progress.

As per the notes to the accounts published along with its quarterly results for the period ended 30 June 2012, the group had receivables of Rs 2773.1 crore on 30 June 2012 (Rs 2369.3 crore on 31 March 2012) from various state electricity utility companies and other customers against sale of power. It has certain long-term borrowings of Rs 2206.1 crore due for repayment in next 12 months and other net current liabilities of Rs 1476.8 crore. Based on the internal assessment and discussions it had with customers and lenders, the company is confident of recovery of receivables and repayment of loans on maturity. However, considerable amount of receivables are under dispute or litigation and, thus, it is not so easy to recover this amount.

The fourth problem centres around the health of Lanco Infratech's subsidiaries. Mid January 2012, Udupi Power Corp, Lanco Infratech's subsidiary, defaulted on its debt repayment. Udupi Power is executing a 1,200 MW thermal power project in Udupi, Karnatka, with a capital cost Rs 6,000 crore. Crisil had downgraded Udupi Power's long-term debt and bank guarantees in January 2012.

Subsidiary Lanco Hills Technology Park Pvt Ltd, which deals in property, is executing integrated real estate project, Lanco Hills, in Hyderabad. The 100-acre project comprises residential, office and IT special economic zone. This is another trouble spot for Lanco Infratech owing to dispute between with the Wakf Board and government of Andhra Pradesh over the title of the land. The Wakf tribunal has restricted Lanco Hills from alienating the property. Lanco Hills has appealed to the Supreme Court, which has granted an interim stay against the orders of high court of Andhra Pradesh and the Wakf Tribunal. The matter continues to be under litigation.

The fifth irritant is corporate governance. In March 20120, Lanco Infratech's shareholders approved sale of its shareholding in some of its subsidiaries and associate companies to its wholly-owned step down subsidiaries and to an associate firm. Accordingly equity stake was sold in March 2012 for cash consideration. The lender and customer approvals and share transfer process is in progress. This was a subject matter of qualification for the year ended 31 March 2012 and limited review report for the quarter ended 30 June 2012.

In February 2012, reports alleged that Lanco Infratech had violated norms of the national solar mission and later rectified that same after a warning from the government. In a clarification issued the Lanco has strongly objected to all the allegations made by Centre for Science and Environment.

As per the information shared by Lanco Infratech through the notes to accounts, investments of the group of Lanco Solar Energy Pvt Ltd (LSEPL), a subsidiary, include investments made line with the Request for Selection and PPA in companies which had won bids for solar projects under Jawaharlal Nehru National Solar Mission Phase-I bid conducted by NTPC Vidyut Vyapar Nigam (NVVN). NVVN has examined these investments and advised some changes in investments, which were complied with. The participation in bids by these investee companies and the shareholding pattern is looked into by a committee set up by the government. The matter is pending and, thus, Lanco has carried these investments at cost in the books of accounts. Receivables of LSEPL include Rs 345 crore, which is the amount due towards EPC contracts executed for investee companies yet to receive financial disbursement towards funding of the projects. LSEPL is optimistic about recovery and taking steps towards the same.

Accounting practices is the sixth issue of agitation. The statutory auditors of Lanco Infratech have qualified their audit report for FY 2012 and limited review report for the quarter ended 30 June 2012 on account of revenue recognition of Udupi Power Corporation, which has recognised supply of power as differential revenue of Rs 206.5 crore for the June 2012 quarter and Rs 545.7 crore for FY 2012, as per the Central Electricity Regulatory Commission (CERC) rate based on the application filed to approve tariff with CERC. Udupi Power is confident of CERC's approval. In the meantime, payments have been released by the customer on the basis of provisional tariff approved by the government of Karnataka. This has resulted in receivables of Rs 1060.8 crore as on 30 June 2012, which are higher by Rs 752.2 crore.

Similarly, Lanco Amarkantak Power Ltd (LAPL), a subsidiary, is under litigation. LAPL has power supply agreement with Haryana Power Generation Corporation Ltd. LAPL has recognised revenue as per the CERC rate based on the application filed to fix tariff with Haryana Electricity Regulatory

LAPL is confident of favorable verdict and has accordingly recognized differential revenue as per the CERC rates, while payments have been released by the customer on the basis of erstwhile power-purchase agreement (PPA) rate. The differential or disputed receivables amounted to Rs 116.3 crore as on 30 June 2012. The auditors have qualified accounts on this count for FY 2012 and its limited review report for the June 2012 quarter.

Lanco Infratech has adopted amended Accounting Standard-11 (on the effects of changes in foreign exchange rates). Thus, from 1 April 2011, the company is adjusting foreign exchange difference (gain or loss) to value of capital assets. This, has helped it to report lower losses. The foreign exchange difference that remains unamortized stood at Rs 282.9 crore.

Promoters hold 72.31% equity stake in Lanco Infratech. The higher promoter holding means it has scope to dilute equity to raise funds that can be used to retire debt. Also, the company has certain investments that could flourish in future. Lanco Infratech holds 5% equity stake in the Indian Energy Exchange, promoted by Financial Technologies and Power Trading Corporation.

The challenges seem to be pouring from all the sides for Lanco Infratech. The company would take at least one to two years to emerge from the financial and operational debacle. The firm plan to offload assets to lighten debt is fine. But it is a gigantic task to sell assets at reasonable valuation unless it is fire-sale. Lanco Infratech is supposedly in discussion with private equity firms Bain Capital and Kohlberg Kravis Roberts to offload equity stake in its power business. The equity stake put on block is believed to be around 30%. The company has not officially commented on this report. Second, the industry scenario for power and infrastructure needs to improve for the company to report financial turnaround in future.

The Central government announced a restructuring package for power distribution companies end September 2012. This is expected to ease the cash crunch faced by several financially sick state electricity boards (SEBs). The contours of the scheme are awaited. If implemented, this could help Lanco as it has receivables from SEBs running into several crore.

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