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Larsen & Toubro
Turning cautious
We believe that L&T's order inflow guidance for FY11 could be at risk. We also
expect slower order flow to impact growth in FY12 and FY13. However, we
believe the medium term outlook is still strong and L&T is well geared for playing
the India capex story. We maintain our Hold rating with a revised TP of Rs1800
Inflows likely to be sedate in 4Q11; order inflow growth could be at risk
Our discussions with various industry players indicate that ordering is likely to be sedate in
4Q11.This is due to delays in land acquisitions, clearances and increased due diligence
following recent scams. Some players are already cutting their inflow guidance. We believe
L&T’s guidance for 25% year-end order inflow growth (implying an inflow of Rs870bn) could
be at risk. L&T announced orders of Rs361bn in 1H11 and Rs117bn to date in 2H11. Even if
one assumes inflows of Rs160bn in 3Q, it would still need inflows of Rs349bn, 47% yoy
growth, to hit guidance.
Slow ordering to impact FY12 and FY13 growth and return ratios
We expect slower ordering to impact growth in FY12 and FY13. At Rs1.15trn, the current
order book is at an all time high. However, longer gestation projects (e.g., power plants) have
dominated recent inflow and account for 47% of 1H11 inflows. Hence, we cut our FY11-13F
sales 1-7% leading to our earnings forecasts for the period falling 3-10%. Also, we expect
increased demands on L&T’s balance sheet in the form of equity contribution given its role as
an asset owner and developer. Slowing inflows and increased execution cycles also leads to
increased working capital requirements, which in turn create additional balance sheet
pressure and are likely to subdue return ratios. We expect adjusted ROEs to decline from a
high of 26% in FY07 to c18% in FY12
Well geared for Indian capex story: Hold maintained
While the above factors may result in near-term issues, we believe L&T is the best geared tothe broad-based Indian capex story among Indian infrastructure companies. The current
order book (at Rs1.15trn) is at an all time high. L&T is getting into higher margin segments,
like power and shipyards. Emerging segments like defence, railways and nuclear power offer
other opportunities. We maintain our Hold rating with a revised target price of Rs1800, based
on our estimate changes and increase in WACC to highlight the current risk free rate.
Infrastructure play; cautious in the short term
We believe L&T’s FY11 order inflow guidance could be at risk. Also, slower orders are
likely to impact growth in FY12 and FY13. However, the medium-term outlook looks strong
and L&T is the well geared to the India capex story, in our view. Hold with a Rs1800 TP.
Short term outlook dim due to macro headwinds
L&T remains the best play on the India infrastructure story, in our view. The company’s order book
is diverse encompassing the entire breadth of the Indian economy. However, the company, by
virtue of being a play on investment activity, is also more susceptible to near-term macro
headwinds. In 9MFY11, we have seen a slow down in project executions, as higher inflation has
led to tightening of liquidity and interest rates. In such a scenario, the company might see a slow
down in project implementation by customers.
Current order book provides revenue visibility; but execution cycle elongating
L&T’s order book at Rs1.15tn provides medium-term revenue visibility. It has reported strong
growth in inflows over the previous few years, which has resulted in an order book CAGR of
32.3% during 2Q04-2Q11. However, the execution period for the order book has slowly
elongated, as seen by the increase in orderbook/F12M (12M forward) gross sales. The order
book/F12M sales increased to c2.1x in 2QFY10, due to longer gestation cycle projects forming a
higher proportion of inflows
Our order inflow analysis suggests that Power, which in 2Q09 comprised only 23% of inflows
(trailing fourth quarter), now comprises 40% of inflows. We feel this might further stretch the
execution cycle of the current order book. The same is likely to result in lower revenue growth in
the coming quarters, despite the current size of order book.
Inflows likely to be sedate in Q4 FY11; order inflow growth could be at risk
Our discussions with various industry players indicate that ordering is likely to be sedate in 4Q.
The reason for the delay the delay in land acquisitions, clearances and increased diligence
following recent scams. Some players are already cutting their inflow guidance. We believe L&T’s
year-end order inflow guidance of 25% growth (implying inflows of Rs870bn) could be at risk. The
company announced orders of Rs361bn in 1H11 and orders of Rs117bn to date 2H11. Projects
like Hyderabad Metro, worth Rs150bn, are yet to see financial closure. While this project is
expected to see financial closure in FY11, it could well slip into early FY12 given that financial
institutions have increased their levels of due diligence.
Slowing order flows will put pressure on balance sheet
We have highlighted in past reports how L&T’s role as an asset owner and developer puts
pressure on its balance sheet. However, slowing inflows coupled with elongation execution cycles
could lead to increased working capital requirements, which would in turn increase balance sheet
pressure. This is likely to subdue L&T’s return ratios further. We expect adjusted ROEs to decline
from a high of 26% in FY07 to 18% in FY12.
We still see L&T as the best India infrastructure story: Hold maintained
While the above factors may result in near-term issues, we believe this company is the best
geared among India infrastructure companies to the broad-based Indian capex story. L&T’s
current order book (at Rs1.15trn) is at an all time high. The company is getting into higher margin
businesses, such as in the power and shipyard segments. Emerging segments like defence,
railways, nuclear power offer further opportunities.
We maintain our Hold rating with a revised target price of Rs1800. We cut our FY11-13F
estimates 3-10% to factor in higher interest costs and lower revenue on account of slower project
execution.
We also increase our WACC to highlight the current risk free rate. This has resulted in our COE
increasing to 14.3% from 12.8%.
We value L&T IDPL at 1.5x total equity invested, which we believe is fair as some of its projects
have started generating cash flows and the pipeline of projects looks strong. We continue to value
InfoTech at 11x FY11F PE based on the average valuation for mid-tier Indian IT companies under
our coverage. We also continue to value L&T Finance Holdings at 2x FY10 P/B, given its average
ROE of 15% for the past four years and the fact that it has strong growth plans.
The stock is currently trading at 22x our FY12F EPS. This implies that the standalone engineering
business trades at 19x FY12F EPS. At our target price, stock would trade at 24x FY12F EPS.
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