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Larsen & Toubro (LART.BO, Buy)
Most resilient in a tough macroeconomic environment – robust order book growth while maintaining
capital returns
We reiterate our Buy rating on L&T and raise our 12-month target price to Rs2,013 (from Rs1,953), as we roll
forward our SOTP-based methodology by 6 months to the average of FY12E-FY13E, reduce our target
multiple for L&T’s E&C business to 20X (vs. 21X earlier), and value L&T finance at listed value.
We lower our expectations of order inflow for the company this year to 8% from 15% earlier. Despite the
significant slowdown being observed for other companies in the construction space, we believe L&T holds an
advantage in that it is able to continue to gain market share in both domestic process and infrastructure
segments and at the same time supplement this through increased orders from the oil and gas segment in
the Middle East.
Although we don’t expect a recovery in order inflow for the broader capital goods sector for the next few
quarters, we are positive on L&T due to its strong order book, deeper product range and service offerings,
and broader geographical reach.
We upgraded our rating on L&T to Buy in February 2011, as we believe three key elements would drive
outperformance for its stock, namely: (1) stabilization in execution cycle for the company (at 31-32
months in FY12E, increasing from 28 months in 2009 to 31 months in FY11), (2) improving returns over
the next 2 years (as investments become operational), and (3) attractive current valuations – 12%
discount to its historical median on P/E (down 23% ytd. vs. the Sensex, which is down 21%).
L&T’s current restructuring could also be a key medium-term catalyst for stocks to unlock value from
investments made in earlier years, especially into L&T IDPL, as many such subsidiaries come up for potential
listing (as announced by the company) – (please refer to our previous report for details: L&T – restructuring in
progress: what are the implications?; part 1, published March 13, 2011).
Catalyst
(1) New order wins, especially in the power and industrials segments, over the near term.
(2) Compression in the execution cycle.
Valuation
Current valuations appear reasonable – with the stock currently trading at a 12-month forward P/E of 19X
(long-term median of 21.5X) and 12-month forward P/B of 3.2X (long-term median of 4.3X), and continuing to
generate ROE of 17%-18% through FY13E. We lower our FY12-FY14 EPS estimates on L&T by 2%-5% on the
back of higher interest expenses incurred by the company as a result of its higher debt levels.
In our view, L&T’s significant exposure to India’s industrial and infrastructure capex makes the stock appealing
from a long-term perspective, while also having a robust ability to deal with the current slowdown in contract
awarding activity, and high commodity and interest rates.
Key downside risks
(1) Aggressive bidding and (2) a delay in the government awarding infrastructure contracts.
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