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Larsen & Toubro (LT)
Industrials
Impressions from site visit: Powerful transformation from field to factory. L&T is
making massive investments in transforming itself into a manufacturing power house in
(1) power - full throttle manufacturing started in BTG with auxiliaries following soon,
(2) forgings - to deepen backward integration, reduce dependence on global suppliers,
(3) shipbuilding and (4) modular fabrication, heavy engineering facilities. Manufacturing
prowess differentiates L&T other contractors, but is likely more cyclical. Retain REDUCE.
Full throttle manufacturing in power equipment facilities; auxiliaries to follow suit
We note that manufacturing in power equipment facilities is in full throttle with (1) one turbine for
APGENCO already delivered and the second under manufacturing; some works started for JP
Nigrie as well, and (2) on the boiler side, start of work for JP Nigrie and Rajpura orders. L&T has
already achieved the high level of indigenization (about 80%) in boiler manufacturing. Turbine
indigenization remains low presently (at 20%) as L&T aims to achieve 40% indigenization by the
time the fifth/sixth unit of turbine is delivered. Auxiliary facilities would be up and running by June
2011, which would help L&T capture about 85% of the EPC value of a thermal power plant.
Forgings, shipbuilding, modular fabrication, heavy engineering facilities to expand manufacturing
L&T is strengthening its manufacturing presence with investments in several new manufacturing
facilities such as (1) forgings - investing Rs17.25 bn in a forge shop with a manufacturing capacity
of 40,000 tons p.a., (2) shipbuilding facility at Katupalli and Hazira and (3) modular fabrication and
heavy engineering facilities at Hazira, Oman and Katupalli.
Manufacturing capability provides competitive edge but is likely more cyclical
We believe L&T’s extensive manufacturing capabilities differentiate it from other contractors.
However, while the manufacturing base provides it a competitive edge, this activity is likely to be
more cyclical in nature. L&T’s secular, long-term play in power and shipbuilding focus on defense
may help mitigate the cyclicality.
Retain estimates and TP of Rs1,775/shre; reiterate REDUCE on several risks to earnings
We have retained our standalone earnings estimates of Rs62.1 and Rs70.3 and our consolidated
earnings estimate of Rs73 and Rs82 for FY2011E and FY2012E, respectively. We retain our
REDUCE rating (target price: Rs1,775) as we believe that L&T’s earnings could face risks related to
(1) lower-than-expected order inflows, (2) margin pressure from rising commodity prices and
change in the order-inflow mix, (3) sedate execution as order book execution cycle elongates and
(4) return-dilutive and high-risk infrastructure investments that may be critical for growth.
Full-throttle manufacturing in power equipment; aggressive indigenization
We note that manufacturing in power equipment facilities is in full throttle with (1) one
turbine for APGENCO already being delivered and a second under manufacturing with some
works started for JP Nigrie as well, and (2) on the boiler side, work for JP Nigrie and Rajpura
power plant has started. Orders for materials have been placed for Karchana as well as
Koradi projects.
There are about 2,000-2,500 employees in the power equipment manufacturing complex
with a very minimal Japanese presence (10-15 employees only) despite their significant
equity stake.
Boiler indigenization (80%) is already very high; turbine currently low (20%) but is
aimed to scale up (40% by 5/6th unit)
L&T is working with indigenization levels of about 20-25% for the first two turbines being
supplied to APGENCO. L&T seems to be currently importing castings (from places such as
France, Italy and this sourcing is independent of MHI). Castings for casings are developed inhouse
and would be progressively indigenized. Currently, rotary blades are completely
sourced from MHI and manufacturing is expected to start two years from now. Stationery
blades (these are integral to casing from our impression) are manufactured in-house already.
L&T aims at 40% indigenization by the time the fifth/sixth unit of turbine is delivered. Two
units are supposed to be delivered by March 2011E, another three in March 2012E and five
in March 2013E.
On the boiler side, L&T seems to be manufacturing pressure parts independently apart from
sourcing pipes, among other parts, from abroad. Separators are imported for the first couple
of units (J P Nigrie) but will be indigenized for subsequent deliveries. L&T seems to have
achieved 85% indigenization in the boiler manufacturing for the first couple of units.
Manufacturing of auxiliaries following suit; captures 85% of power EPC value
Power auxiliary facilities are also under construction and would be up and running by June
2011, which is about the time that such auxiliaries would be needed as per the delivery
schedule of first few orders. The scope of power auxiliaries is quite comprehensive and
includes Electrostatic precipitators, Axial fans, air pre-heaters, coal pulverizes and piping. The
combined L&T E&C expertise in civil components such as coal handling plants, switchyard,
chimney, cooling towers gives it an opportunity to capture about 85% of the EPC value of
the thermal power plant. This would be a key competitive edge in the sector.
Forging facility would add to the manufacturing edge
L&T is investing Rs17.25 bn in a forge shop which would have manufacturing capacity of
40,000 tons per annum of finished forgings and would be useful for producing forgings for
Nuclear (single piece of forging as large as about 400 tons), power rotor and generator
stators (single forgings of about 150-200 tons) and hydrocarbon reactor components
(forgings of 50-60 tons). India has established manufacturing facilities of about 50 tons of
forgings only.
Next step of capacity expansion once visibility on sector builds up; worried on
coal, imported equipment
L&T has manufacturing capabilities for 4,000 MW (can be stretched to 5,000 MW) of
equipment—it will evaluate the possibility of taking this up to 6,000 MW. However, L&T
seems to be worried about two key issues:
Coal supply position. L&T is worried about issues such as (1) CIL production target cuts,
(2) “no-go” area restrictions, (3) no coal block allocations till new policy is in place and (4)
no coal linkages being awarded since April 2010
Chinese equipment imports: L&T argues that lower Chinese Yuan endows Chinese
equipment with a huge advantage on the price. L&T is addressing this in two ways:
1. Price and delivery. Reducing its own price and delivery by vertical integration and
indigenization. L&T is now quoting 42 months delivery for a first supercritical unit
versus 48-51 months earlier and 4 months for each successive unit versus 6 months
earlier
2. Educating customer on lifecycle cost (as much as original equipment in NPV
terms). NTPC example on BHEL equipment seems to suggest that the lifecycle costs
of a thermal power plant including spares over the life etc. in present value terms is
2X the original equipment price and thus it needs to be considered upfront. L&T
believes that Chinese plants would have very high depreciation and an asset that is
supposed to work for 30-35 years may lose value in the first 4-5 years.
Seems positive in the long term though citing Chinese capacity addition example
L&T seems very positive on the sector in the long term, offering a comparison with China to
debunk the notion that equipment supply creates over capacity.
Delays from BHEL and Tata projects (on BoP) in APGenco delaying L&T deliveries
L&T claims that despite being a recent starter, it has made deliveries of turbine for
APGENCO’s Krishnapatnam plant in time while the BHEL supplies are running delayed by 15
months and BoP by Tata Projects is running delayed by 9-10 months. Delays on the part of
other vendors is so much that L&T finding it difficult to store the finished products safely
onsite.
Tough logistics: JP Nigrie supplies involve sea, river and land transport
L&T management says that equipment supply for the JP Nigrie project is transported to
Hooghly by sea, transported onwards through the river route to a place close to Nigrie and
then by land to the Nigrie power plant for the last 200 kms. Most often, existing bridges are
unable to take the load of heavy power plant equipments so temporary bridges need to be
erected to supply the equipment to the plant site.
Gives thumbs up to government for moving strongly in favor of supercritical
equipment and other initiatives
L&T seemed satisfied with the government in terms of its strong push for super critical
technology as that has opened up new opportunity for L&T apart from addressing
environmental concerns. L&T felt that sector has gained momentum because of Electricity
Act 2003 and steps such as Ultra Mega Power Projects (UMPP). However the momentum
would slow down unless critical reforms are not carried out in coal allocation.
Deeper manufacturing differentiates L&T from plain vanilla contractors
L&T is strengthening its manufacturing presence and is adding significant capacities in Hazira
(casting, forging, modular fabrication, heavy engineering facilities), Katupalli (shipbuilding,
ship repair, modular fabrication facility, heavy engineering) and Oman (modular fabrication
facility). Such capacity addition keeps it ahead of competitors and differentiates it from other
construction contractors. L&T has 750 acres of facility at Hazira and 1,200 acres at Katupalli.
When we last visited Hazira plant in January 2009, we believe that only 250 acres at Hazira
was utilized (entire power complex is a recent addition).
Reiterate REDUCE with a target price of Rs1,775/share
We have retained our standalone earnings estimates of Rs62.1 and Rs70.3 and our
consolidated earnings estimate of Rs73 and Rs82 for FY2011E and FY2012E, respectively.
Our SOTP-based target price of Rs1,775/share is comprised of (1) Rs1,272/share from the
core construction business based on 18X FY2012E expected earnings, (2) Rs219/share from
L&T’s service subsidiaries, (3) Rs76/share from the manufacturing subsidiaries, (4)
Rs107/share from the infrastructure SPVs and (5) Rs94/share from other subsidiaries and
investments.
We retain our REDUCE rating on the stock as we believe that L&T’s earnings could face
potential risks related to (1) lower-than-expected order inflows, (2) margin pressure given
rising commodity prices and change in order inflows mix, (3) sedate execution as order book
execution cycle elongates and (4) return-dilutive and high-risk infrastructure investments
which may be necessary for growth.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Larsen & Toubro (LT)
Industrials
Impressions from site visit: Powerful transformation from field to factory. L&T is
making massive investments in transforming itself into a manufacturing power house in
(1) power - full throttle manufacturing started in BTG with auxiliaries following soon,
(2) forgings - to deepen backward integration, reduce dependence on global suppliers,
(3) shipbuilding and (4) modular fabrication, heavy engineering facilities. Manufacturing
prowess differentiates L&T other contractors, but is likely more cyclical. Retain REDUCE.
Full throttle manufacturing in power equipment facilities; auxiliaries to follow suit
We note that manufacturing in power equipment facilities is in full throttle with (1) one turbine for
APGENCO already delivered and the second under manufacturing; some works started for JP
Nigrie as well, and (2) on the boiler side, start of work for JP Nigrie and Rajpura orders. L&T has
already achieved the high level of indigenization (about 80%) in boiler manufacturing. Turbine
indigenization remains low presently (at 20%) as L&T aims to achieve 40% indigenization by the
time the fifth/sixth unit of turbine is delivered. Auxiliary facilities would be up and running by June
2011, which would help L&T capture about 85% of the EPC value of a thermal power plant.
Forgings, shipbuilding, modular fabrication, heavy engineering facilities to expand manufacturing
L&T is strengthening its manufacturing presence with investments in several new manufacturing
facilities such as (1) forgings - investing Rs17.25 bn in a forge shop with a manufacturing capacity
of 40,000 tons p.a., (2) shipbuilding facility at Katupalli and Hazira and (3) modular fabrication and
heavy engineering facilities at Hazira, Oman and Katupalli.
Manufacturing capability provides competitive edge but is likely more cyclical
We believe L&T’s extensive manufacturing capabilities differentiate it from other contractors.
However, while the manufacturing base provides it a competitive edge, this activity is likely to be
more cyclical in nature. L&T’s secular, long-term play in power and shipbuilding focus on defense
may help mitigate the cyclicality.
Retain estimates and TP of Rs1,775/shre; reiterate REDUCE on several risks to earnings
We have retained our standalone earnings estimates of Rs62.1 and Rs70.3 and our consolidated
earnings estimate of Rs73 and Rs82 for FY2011E and FY2012E, respectively. We retain our
REDUCE rating (target price: Rs1,775) as we believe that L&T’s earnings could face risks related to
(1) lower-than-expected order inflows, (2) margin pressure from rising commodity prices and
change in the order-inflow mix, (3) sedate execution as order book execution cycle elongates and
(4) return-dilutive and high-risk infrastructure investments that may be critical for growth.
Full-throttle manufacturing in power equipment; aggressive indigenization
We note that manufacturing in power equipment facilities is in full throttle with (1) one
turbine for APGENCO already being delivered and a second under manufacturing with some
works started for JP Nigrie as well, and (2) on the boiler side, work for JP Nigrie and Rajpura
power plant has started. Orders for materials have been placed for Karchana as well as
Koradi projects.
There are about 2,000-2,500 employees in the power equipment manufacturing complex
with a very minimal Japanese presence (10-15 employees only) despite their significant
equity stake.
Boiler indigenization (80%) is already very high; turbine currently low (20%) but is
aimed to scale up (40% by 5/6th unit)
L&T is working with indigenization levels of about 20-25% for the first two turbines being
supplied to APGENCO. L&T seems to be currently importing castings (from places such as
France, Italy and this sourcing is independent of MHI). Castings for casings are developed inhouse
and would be progressively indigenized. Currently, rotary blades are completely
sourced from MHI and manufacturing is expected to start two years from now. Stationery
blades (these are integral to casing from our impression) are manufactured in-house already.
L&T aims at 40% indigenization by the time the fifth/sixth unit of turbine is delivered. Two
units are supposed to be delivered by March 2011E, another three in March 2012E and five
in March 2013E.
On the boiler side, L&T seems to be manufacturing pressure parts independently apart from
sourcing pipes, among other parts, from abroad. Separators are imported for the first couple
of units (J P Nigrie) but will be indigenized for subsequent deliveries. L&T seems to have
achieved 85% indigenization in the boiler manufacturing for the first couple of units.
Manufacturing of auxiliaries following suit; captures 85% of power EPC value
Power auxiliary facilities are also under construction and would be up and running by June
2011, which is about the time that such auxiliaries would be needed as per the delivery
schedule of first few orders. The scope of power auxiliaries is quite comprehensive and
includes Electrostatic precipitators, Axial fans, air pre-heaters, coal pulverizes and piping. The
combined L&T E&C expertise in civil components such as coal handling plants, switchyard,
chimney, cooling towers gives it an opportunity to capture about 85% of the EPC value of
the thermal power plant. This would be a key competitive edge in the sector.
Forging facility would add to the manufacturing edge
L&T is investing Rs17.25 bn in a forge shop which would have manufacturing capacity of
40,000 tons per annum of finished forgings and would be useful for producing forgings for
Nuclear (single piece of forging as large as about 400 tons), power rotor and generator
stators (single forgings of about 150-200 tons) and hydrocarbon reactor components
(forgings of 50-60 tons). India has established manufacturing facilities of about 50 tons of
forgings only.
Next step of capacity expansion once visibility on sector builds up; worried on
coal, imported equipment
L&T has manufacturing capabilities for 4,000 MW (can be stretched to 5,000 MW) of
equipment—it will evaluate the possibility of taking this up to 6,000 MW. However, L&T
seems to be worried about two key issues:
Coal supply position. L&T is worried about issues such as (1) CIL production target cuts,
(2) “no-go” area restrictions, (3) no coal block allocations till new policy is in place and (4)
no coal linkages being awarded since April 2010
Chinese equipment imports: L&T argues that lower Chinese Yuan endows Chinese
equipment with a huge advantage on the price. L&T is addressing this in two ways:
1. Price and delivery. Reducing its own price and delivery by vertical integration and
indigenization. L&T is now quoting 42 months delivery for a first supercritical unit
versus 48-51 months earlier and 4 months for each successive unit versus 6 months
earlier
2. Educating customer on lifecycle cost (as much as original equipment in NPV
terms). NTPC example on BHEL equipment seems to suggest that the lifecycle costs
of a thermal power plant including spares over the life etc. in present value terms is
2X the original equipment price and thus it needs to be considered upfront. L&T
believes that Chinese plants would have very high depreciation and an asset that is
supposed to work for 30-35 years may lose value in the first 4-5 years.
Seems positive in the long term though citing Chinese capacity addition example
L&T seems very positive on the sector in the long term, offering a comparison with China to
debunk the notion that equipment supply creates over capacity.
Delays from BHEL and Tata projects (on BoP) in APGenco delaying L&T deliveries
L&T claims that despite being a recent starter, it has made deliveries of turbine for
APGENCO’s Krishnapatnam plant in time while the BHEL supplies are running delayed by 15
months and BoP by Tata Projects is running delayed by 9-10 months. Delays on the part of
other vendors is so much that L&T finding it difficult to store the finished products safely
onsite.
Tough logistics: JP Nigrie supplies involve sea, river and land transport
L&T management says that equipment supply for the JP Nigrie project is transported to
Hooghly by sea, transported onwards through the river route to a place close to Nigrie and
then by land to the Nigrie power plant for the last 200 kms. Most often, existing bridges are
unable to take the load of heavy power plant equipments so temporary bridges need to be
erected to supply the equipment to the plant site.
Gives thumbs up to government for moving strongly in favor of supercritical
equipment and other initiatives
L&T seemed satisfied with the government in terms of its strong push for super critical
technology as that has opened up new opportunity for L&T apart from addressing
environmental concerns. L&T felt that sector has gained momentum because of Electricity
Act 2003 and steps such as Ultra Mega Power Projects (UMPP). However the momentum
would slow down unless critical reforms are not carried out in coal allocation.
Deeper manufacturing differentiates L&T from plain vanilla contractors
L&T is strengthening its manufacturing presence and is adding significant capacities in Hazira
(casting, forging, modular fabrication, heavy engineering facilities), Katupalli (shipbuilding,
ship repair, modular fabrication facility, heavy engineering) and Oman (modular fabrication
facility). Such capacity addition keeps it ahead of competitors and differentiates it from other
construction contractors. L&T has 750 acres of facility at Hazira and 1,200 acres at Katupalli.
When we last visited Hazira plant in January 2009, we believe that only 250 acres at Hazira
was utilized (entire power complex is a recent addition).
Reiterate REDUCE with a target price of Rs1,775/share
We have retained our standalone earnings estimates of Rs62.1 and Rs70.3 and our
consolidated earnings estimate of Rs73 and Rs82 for FY2011E and FY2012E, respectively.
Our SOTP-based target price of Rs1,775/share is comprised of (1) Rs1,272/share from the
core construction business based on 18X FY2012E expected earnings, (2) Rs219/share from
L&T’s service subsidiaries, (3) Rs76/share from the manufacturing subsidiaries, (4)
Rs107/share from the infrastructure SPVs and (5) Rs94/share from other subsidiaries and
investments.
We retain our REDUCE rating on the stock as we believe that L&T’s earnings could face
potential risks related to (1) lower-than-expected order inflows, (2) margin pressure given
rising commodity prices and change in order inflows mix, (3) sedate execution as order book
execution cycle elongates and (4) return-dilutive and high-risk infrastructure investments
which may be necessary for growth.
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