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Larsen & Toubro (L&T) reported strong revenues and earnings growth of
40% and 16%, respectively, in Q3FY11, ahead of our and consensus
estimates, led by strong execution in the E&C division. However, margins
came off 151bps Y-o-Y, to 10.8%, as some large value contracts did not
achieve minimum revenue threshold and input cost pressures pulled down
earnings. New orders disappointed with 25% Y-o-Y decline, led by muted
inflows and order deferrals.
Execution picks up; margin pressure slows earnings growth
L&T reported strong execution during Q3FY11 with revenue growth of 40%, to
INR 114 bn, led by the E&C segment. Higher raw material cost (up 172bps Y-o-
Y, to 78.5% of sales) put pressure on EBITDA margin that stood at 10.8% (down
151bps Y-o-Y) during Q3FY11. This is primarily due to non-achievement of
minimum revenue threshold in certain projects, which is expected in Q4FY11.
This led to slower earnings growth at 16% to INR 8 bn.
Order inflows continue to disappoint; cut FY11 inflow estimate
L&T reported a sharp dip of 25% Y-o-Y in fresh orders during Q3FY11, as several
orders have been deferred to FY12 due to various reasons. Lower order inflows
were primarily driven by the power and process verticals which saw dip of 54%
and 41%, respectively, in order inflows during the quarter. For 9mFY11, order
inflows disappointed with 8% growth Y-o-Y. We have cut our order inflow
estimate by 8% to INR 800 bn from INR 860 bn for FY11, implying a 28% asking
growth rate in Q4FY11.The order backlog of L&T at the end of Q3FY11 stands at
INR 1148.8 bn.
Outlook and valuations: Negatives priced in; maintain ‘HOLD’
While the company has reported strong execution numbers for 9mFY11, new
order growth has clearly disappointed. We believe the company will miss its FY11
new order growth guidance of 25% and expect ~16-18% new order growth.
While overall macro concerns persist regarding slow pace of activities in power,
oil & gas etc, we believe, the recent sharp correction in L&T captures majority of
medium-term concerns with limited downside. While we maintain our FY11
earnings estimates, we marginally cut our FY12 earnings by 5%, building in
impact of lower order inflow growth in FY11. We maintain our ‘HOLD/Sector
Performer’ recommendation/rating with a revised SOTP of INR 1,821 (INR
1,493 for parent company) against INR 1,940 earlier.
Segmental analysis
Engineering and construction: The segment saw sharp revenue growth of 42.4% Y-o-
Y, to INR 100 bn, led by pick up in execution of several projects, especially the power
project that increased overall revenue share to 86% during the quarter. Increased raw
material prices, particularly steel and job mix, led to a 153bps Y-o-Y decline in EBIT
margin, to 10.6% during Q3FY11. For 9mFY11, revenues increased 21% Y-o-Y while
EBIT margin improved 28bps Y-o-Y to 11.3%.
Machinery & industrial products: Led by improved traction in mining and construction
equipment business, together with the industrial valves business, the division posted
strong revenue growth of 15% Y-o-Y, to INR 6.8 bn. However, input cost pressure led to
151bps Y-o-Y decline in EBIT margins to 18.9% during the quarter. For 9mFY11,
revenues increased 25% while EBIT margin declined 155bps to 18.5%, Y-o-Y.
Electrical & electronics: The segment posted moderate revenue growth of 10.7% Y-o-
Y, to INR 8 bn, driven by pick-up in industrial and agricultural demand. Increase in
commodity prices (mainly silver and copper), together with drop in exports, led to
124bps Y-o-Y dip in EBIT margin to 10.9% during the quarter. For 9mFY11, revenues
increased 10.5% Y-o-Y, while EBIT margin declined 187bps Y-o-Y to 11.2%.
Company Description
LT, headquartered in Mumbai, is a technology-driven engineering and construction
organization, and one of the largest companies in India’s private sector. It has additional
interests in manufacturing, services, and information technology. A strong customerfocused
approach and the constant quest for top-class quality has enabled the company
attain and sustain leadership in its major lines of businesses over seven decades. LT has
an international presence, with a global spread of offices. A thrust on international
business over the past few years has seen overseas earnings growing to 18% of total
revenues. With factories and offices located around the country, further supplemented by
a wide marketing and distribution network, LT’s image and equity extend to virtually
every district of India.
Investment Theme
LT’s standalone business operations have gathered significant traction over the past few
years with revenue CAGR of 32% over FY04-06; this is commendable, given the
company’s scale of operations. The order backlog currently stands in excess of INR 1154
bn and is likely to swell with LT’S entry into new verticals like ship building, aviation,
nuclear, and defense, which have immense potential. We expect LT’s standalone
revenues and earnings to grow at CAGR of 22% over FY10-12E.
A strong balance sheet, sound execution engine, range of capabilities and integrated set
of operations (tailored to suit the India infrastructure growth story), lead us to repose
faith in the default India infrastructure story—LT.
Key Risks
Economy slowdown: Being a play across India growth spectrum, any slowdown in the
broad economy will impact LT’s operations. Also, given that a large part of the
infrastructure capex is government-driven, any political instability could impact the rollout
plans and, in turn, LT’s growth plans.
Raw material costs and execution risks: Any sudden surge in prices of base raw
material comprising steel, aluminum, cement etc., could detrimentally affect the
company’s margin/operations, despite most contracts having a built-in price escalation
clause. Also, given the scale of projects being executed by LT, any execution delay could
cost company dearly.
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