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UBS Investment Research
L & T
Order pick-up to drive stock performance
Trading at the lower-end of historical valuation range
L&T is currently trading at 18x 1-yr forward EPS; lower than the average of its
historical trading range. Though order flows so far have been lower than expected,
we believe these near-term concerns are now priced in and the valuations are
attractive (EPS CAGR of ~21% over FY11-13E). In our view L&T remains the
key play on India’s structurally strong infrastructure growth story.
Execution remains strong; order pick-up to drive stock performance
Order book is healthy at Rs1,148bn (~2.3x 1-yr forward sales). Execution is strong
as 9mFY11 revenues were up 22% YoY (vs. other E&C companies had sluggish
growth). In our recent meeting, the company highlighted that this has been due to
careful project selection, ensuring funding availability for projects and regular
monitoring. There have been signs lately, led by provision of clearances/few
project awards, that ordering could pick-up in a few sectors like power/roads. This
is likely to improve sentiment and drive stock performance in our view.
Operating leverage could support margins
Margins have increased consistently over the last seven years, on the back of
strong operating leverage. We already factor in a 50bps decline in margins in FY11
and believe that operating leverage could offset any pressure due to raw material
cost push. We reduce our earnings estimates by about 1%-6% over FY11-13,
driven by lower order inflows.
Valuation: Maintain Buy; top pick in India infrastructure space
We revise our SOTP-based price target to Rs2,100 based on revision in our
estimates. We reiterate our Buy rating.
Valuations are attractive
We believe L&T is trading at attractive valuations at current levels as it is
currently at lower than the average of its historical trading range.
Ordering activity shows signs of improvement
L&T’s Order inflow Guidance
In the beginning of FY11, L&T had given a guidance of 25% YoY increase in
order inflows in FY11. Its FY10 order flows were ~Rs695bn, implying order
inflow guidance of Rs870bn in FY11. However, order intake has been Rs495bn
in 9mFY11, which means order intake would need to be Rs375bn in Q4FY11
(implying a growth of 57%).
Key Issues
L&T’s order-intake in Q3FY11 declined 25% YoY. Order inflows had been
lower-than-expected due to a variety of reasons- 1) delays by clients (likely due
to volatility in economic environment, though customers had not cancelled
projects), 2) government postponing ordering activity (reasons could be
compulsions of coalition government, not much work happening in last session
of Parliament), 3) political issues (Telangana, various scams/probes, upcoming
assembly elections in West Bengal/Tamil Nadu,), 4) delays in environmental
clearances and land acquisitions, 5) delays in coal-based projects due to
postponements of coal block allocations (discussion over Go-No Go areas), 6)
delays in gas-based projects (power plants, pipelines, fertilizers) due to lower
gas production and 7) to some extent financial problems of some customers
(though this is not significant).
Signs of pick-up
In the month of March, there seems to be some progress around the above
concerns as suggested by media reports-
The government has cleared 77 projects of Coal India with a production
capacity of ~185mt.
An environmental ministry panel has cleared nine power projects with a
capacity of 5,674MW.
NHAI ordering activity- NHAI has begun the ordering activity in the road
sector, after a gap, post the change in the minister. This is significant as our
channel checks also suggest that a lot of the ground-work that is timeconsuming
on a large number of projects have been done and NHAI can do
financial bidding of these projects in a relatively shorter time-frame.
Ordering activity from Power Grid, India’s largest transmission utility, has
started- BHEL, ABB have received large orders.
We recently met with BHEL management and they expressed confidence in
achieving Rs600bn order inflow guidance for FY11.
Hence, we believe there could be a pick-up in ordering activity in the power and
road segments, the two largest sub-sectors of infrastructure.
We also note that in the Middle-East, L&T’s projects are primarily in the
geographies of UAE, Oman, Abu Dhabi and Qatar, pertaining to T&D and civil
infrastructure largely. Hence, the company is not facing issues in project
execution due to the Middle-East stir.
We currently estimate FY11 order inflow growth of 10% yoy (9m order inflow
growth was 8% yoy) and we believe this could be achievable as a) 4Q order
inflow is usually strong (as per historical trends), b) L&T could book its
Hyderabad metro order (Projects size Rs150bn, though order-booking would be
lower) and c) news flow on order announcement remains strong in last week of
March and first week of April.
Operating leverage could support margins
Our estimates already factor in a 50bps decline in margins (to 12.3% at the
standalone level from 12.8% achieved in FY10). L&T has been able to increase
margins in the last few years in spite of commodity cycles and we think that any
raw material cost push could be offset by strong operating leverage. In our
recent meeting, the company highlighted that it has been able to maintain
revenue growth, unlike its other E&C peers, due to- 1) a strong order backlog
which is built-up on careful client selection, 2) adequate funding that ensures
that no project is held-up due to funding issues, 3) milestone-linked payments
for sub-contractors that ensures timely execution and 4) regular management
monitoring of all projects.
Currently, about two-thirds of the order backlog is comprised of variable-priced
contracts while about one-third is on fixed-price.
Key catalysts for the stock
In addition to pick-up in the ordering activity, the following are the likely
catalysts in our view- Financial closure of the Hyderabad metro project- likely in
March, Commissioning of the Dhamra Port- likely in April, Listing of L&T
Finance- likely in Q1FY12 (depending on market conditions) and NTPC bulk
tendering.
L & T
Larsen and Toubro (L&T) is India’s largest engineering and construction (E&C)
company, and is the only dedicated engineering procurement and contracts
(EPC) company in India. It also has interests in electrical goods such as
switchgears and control panels. L&T has several subsidiaries engaged in various
businesses such as IT services, financing of industrial equipment, collection of
toll from roads constructed under the BOT scheme, and power generation. It has
also diversified into shipbuilding and power plant equipment businesses.
Statement of Risk
We believe the main risks to our price target and estimates are: 1) a change in
order inflow estimates, and 2) execution issues.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
L & T
Order pick-up to drive stock performance
Trading at the lower-end of historical valuation range
L&T is currently trading at 18x 1-yr forward EPS; lower than the average of its
historical trading range. Though order flows so far have been lower than expected,
we believe these near-term concerns are now priced in and the valuations are
attractive (EPS CAGR of ~21% over FY11-13E). In our view L&T remains the
key play on India’s structurally strong infrastructure growth story.
Execution remains strong; order pick-up to drive stock performance
Order book is healthy at Rs1,148bn (~2.3x 1-yr forward sales). Execution is strong
as 9mFY11 revenues were up 22% YoY (vs. other E&C companies had sluggish
growth). In our recent meeting, the company highlighted that this has been due to
careful project selection, ensuring funding availability for projects and regular
monitoring. There have been signs lately, led by provision of clearances/few
project awards, that ordering could pick-up in a few sectors like power/roads. This
is likely to improve sentiment and drive stock performance in our view.
Operating leverage could support margins
Margins have increased consistently over the last seven years, on the back of
strong operating leverage. We already factor in a 50bps decline in margins in FY11
and believe that operating leverage could offset any pressure due to raw material
cost push. We reduce our earnings estimates by about 1%-6% over FY11-13,
driven by lower order inflows.
Valuation: Maintain Buy; top pick in India infrastructure space
We revise our SOTP-based price target to Rs2,100 based on revision in our
estimates. We reiterate our Buy rating.
Valuations are attractive
We believe L&T is trading at attractive valuations at current levels as it is
currently at lower than the average of its historical trading range.
Ordering activity shows signs of improvement
L&T’s Order inflow Guidance
In the beginning of FY11, L&T had given a guidance of 25% YoY increase in
order inflows in FY11. Its FY10 order flows were ~Rs695bn, implying order
inflow guidance of Rs870bn in FY11. However, order intake has been Rs495bn
in 9mFY11, which means order intake would need to be Rs375bn in Q4FY11
(implying a growth of 57%).
Key Issues
L&T’s order-intake in Q3FY11 declined 25% YoY. Order inflows had been
lower-than-expected due to a variety of reasons- 1) delays by clients (likely due
to volatility in economic environment, though customers had not cancelled
projects), 2) government postponing ordering activity (reasons could be
compulsions of coalition government, not much work happening in last session
of Parliament), 3) political issues (Telangana, various scams/probes, upcoming
assembly elections in West Bengal/Tamil Nadu,), 4) delays in environmental
clearances and land acquisitions, 5) delays in coal-based projects due to
postponements of coal block allocations (discussion over Go-No Go areas), 6)
delays in gas-based projects (power plants, pipelines, fertilizers) due to lower
gas production and 7) to some extent financial problems of some customers
(though this is not significant).
Signs of pick-up
In the month of March, there seems to be some progress around the above
concerns as suggested by media reports-
The government has cleared 77 projects of Coal India with a production
capacity of ~185mt.
An environmental ministry panel has cleared nine power projects with a
capacity of 5,674MW.
NHAI ordering activity- NHAI has begun the ordering activity in the road
sector, after a gap, post the change in the minister. This is significant as our
channel checks also suggest that a lot of the ground-work that is timeconsuming
on a large number of projects have been done and NHAI can do
financial bidding of these projects in a relatively shorter time-frame.
Ordering activity from Power Grid, India’s largest transmission utility, has
started- BHEL, ABB have received large orders.
We recently met with BHEL management and they expressed confidence in
achieving Rs600bn order inflow guidance for FY11.
Hence, we believe there could be a pick-up in ordering activity in the power and
road segments, the two largest sub-sectors of infrastructure.
We also note that in the Middle-East, L&T’s projects are primarily in the
geographies of UAE, Oman, Abu Dhabi and Qatar, pertaining to T&D and civil
infrastructure largely. Hence, the company is not facing issues in project
execution due to the Middle-East stir.
We currently estimate FY11 order inflow growth of 10% yoy (9m order inflow
growth was 8% yoy) and we believe this could be achievable as a) 4Q order
inflow is usually strong (as per historical trends), b) L&T could book its
Hyderabad metro order (Projects size Rs150bn, though order-booking would be
lower) and c) news flow on order announcement remains strong in last week of
March and first week of April.
Operating leverage could support margins
Our estimates already factor in a 50bps decline in margins (to 12.3% at the
standalone level from 12.8% achieved in FY10). L&T has been able to increase
margins in the last few years in spite of commodity cycles and we think that any
raw material cost push could be offset by strong operating leverage. In our
recent meeting, the company highlighted that it has been able to maintain
revenue growth, unlike its other E&C peers, due to- 1) a strong order backlog
which is built-up on careful client selection, 2) adequate funding that ensures
that no project is held-up due to funding issues, 3) milestone-linked payments
for sub-contractors that ensures timely execution and 4) regular management
monitoring of all projects.
Currently, about two-thirds of the order backlog is comprised of variable-priced
contracts while about one-third is on fixed-price.
Key catalysts for the stock
In addition to pick-up in the ordering activity, the following are the likely
catalysts in our view- Financial closure of the Hyderabad metro project- likely in
March, Commissioning of the Dhamra Port- likely in April, Listing of L&T
Finance- likely in Q1FY12 (depending on market conditions) and NTPC bulk
tendering.
L & T
Larsen and Toubro (L&T) is India’s largest engineering and construction (E&C)
company, and is the only dedicated engineering procurement and contracts
(EPC) company in India. It also has interests in electrical goods such as
switchgears and control panels. L&T has several subsidiaries engaged in various
businesses such as IT services, financing of industrial equipment, collection of
toll from roads constructed under the BOT scheme, and power generation. It has
also diversified into shipbuilding and power plant equipment businesses.
Statement of Risk
We believe the main risks to our price target and estimates are: 1) a change in
order inflow estimates, and 2) execution issues.
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