What's changed
LT has outperformed BHEL by more than 7% over the past 3 weeks. We
believe this is primarily driven by investors looking for exposure to India’s
improving Infrastructure and Industrial capex cycle.
Implications
We retain our Neutral rating on L&T and continue to prefer it over Sellrated
BHEL (BHEL.BO, Rs 2,464.75 as of Sep 22 close) given L&T’s broad
and deep exposure to the capex cycle, its robust order book of Rs1,078bn
as of June-end 2010 and continued strong order inflows (c. Rs110bn in
July-August 2010). But while we believe L&T continues to offer
good exposure to capex cycle, we think the stock’s performance
will be driven by market rerating rather than earnings surprises
(our EPS ests are in line with consensus for FY11E and FY12E).
On the other hand, BHEL’s exposure to structural pricing and margin risks
in India’s power equipment market keep us negative on the stock. We
believe the heavy equipment supply space in India is reaching critical
mass and various domestic companies are now competing to establish
market share and presence, potentially at the cost of returns in the interim.
Valuation
We raise our SOTP-based 12-m TP for L&T to Rs1,683 from Rs1,650 as we
roll forward our parent and subsidiary valuations to avg FY11E and FY12E.
L&T currently trades at 12-m fwd P/E of 25.4X, an 18% premium to its 5-yr
average 12-m fwd P/E, vs. BHEL trading at a 12-m fwd P/E of 22.2X, a 1%
discount to its 5-yr median 12-m fwd P/E. We fine-tune FY11E-13E EPS.
Key risks
Downside: 1) Aggressive bidding on new projects, 2) steep rise in interest
rates, 3) volatile construction material costs. Upside: 1) Stronger-thanexpected
ramp-up in execution.
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