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Larsen & Toubro (LT)
Industrials
Better risk-reward; capex cycle, inflow quality & competition concerns continue.
The recent correction provides improves the risk-reward tradeoff (standalone at 13.5X
FY2013E P/E); nevertheless, we retain our REDUCE rating due to (1) weak capex cycle,
(2) quality of inflows (Rs200 bn+ may not be ready for execution) and (3) potential
disappointment (execution and margins) in near-term earnings, (4) increasing
competition across sectors. Inflow guidance is not key; quality (ready, margins and
Wcap) is key.
Much better risk-reward post recent correction; prices in reasonable stress case
The recent price correction (down 17% in the past three months) provides a better risk-reward
tradeoff for L&T. L&T (at Rs1,450/share, adjusted for Rs440/share for value from subsidiaries) is
trading at relatively attractive valuation of 13.5X FY2013E standalone EPS. At about Rs1,450, the
stock seems to price in a reasonable stress case scenario with standalone EPS of about Rs70 for
FY2013E at 15X P/E and subsidiaries valuation of Rs400/share (both 10% lower than our base
case). This EPS would result from 15% revenue growth in FY2013E post 19% in FY2012E and a
steep total of 180 bps margins drop in two years.
Inflow growth guidance may not be as important; quality (ready, margins, working capital) is key
There is some apprehension about L&T’s guidance at the end of 2Q, however, we would not be
overly concerned if guidance is lowered, as even flat (Rs800 bn) ordering would be enough to
maintain growth momentum. Execution readiness, margins and working capital are more
important for the order inflows. E.g. about Rs200 bn+ of orders in the past two years may not be
execution ready, apart from about Rs206 bn of orders from commercial and residential real estate.
There is a marginal risk of L&T downgrading revenue growth guidance from 25% as in FY2007
and FY2010, if on-ground execution is slower based on review of its business units performance
before 2Q results.
Retain REDUCE on weak capex cycle, potential disappointment and increasing competition
Our outlook for the stock is less negative, however, we are constrained to retain our REDUCE
rating on account of (1) weak capex cycle as reflected in various variables, (2) quality of order
booking (Rs200 bn+ may not be ready for execution), (3) potential disappointment in near-term
earnings performance versus reasonably high expectations, (4) potential for sharper-than-expected
margin contraction and (5) increasing competition across sectors along with clients breaking orders
in small parts reducing L&T’s size advantage. We revise our standalone (consolidated) estimates to
Rs69.3 (Rs79) and Rs77.1 (Rs91.7) from Rs69 (Rs79.6) and Rs82 (Rs98.2) for FY2012E and
FY2013E and correspondingly revise our target price to Rs1,625/share (from Rs1,800/share).
Order inflow growth may not be as relevant, while quality of inflows is key
We believe concerns related to potential miss of order inflow growth guidance may not be
as relevant. Even if the company reports no growth in order inflows in FY2012-13E (implying
inflows of about Rs800 bn each year), this would be sufficient to maintain a revenue growth
momentum of about 15-20% over the same period. The quality of order inflows (in terms of
potential margins, client profile etc) would be a more important factor to watch.
We build in relatively low order inflow growth assumption of only 2% in FY2012E versus
management guidance of 10-15% growth and about 7% in FY2013E.
Several orders may not be ready for execution in the near term
We note several orders to the tune of about Rs200 bn which may not be ready for execution
in the near term. These include in-house development projects such as Hyderabad Metro
project, BPP Tollway and Rajpura thermal power plant. Power equipment/ EPC orders (thirdparty)
may also face some delays as the sector is wrought with several challenges such as
environmental clearance issues, coal linkages etc.
Rs137 bn+ (about 15%) order inflows in FY2011 and FY12E have come in from the
industrial and commercial buildings segment, wherein execution may be slower than
expected.
Order inflows just about keeping pace
L&T has announced orders to the tune of about Rs40 bn post 1QFY12-end which leads to
total order inflows of about Rs210 bn in FY2012 so far (reported inflows of Rs162 bn in
1QFY12 + announcements post 1QFY12). These inflows were primarily led by the industrial
& commercial buildings segment, which contributed about Rs32 bn of the total inflow
announcements. The company had also seen a pick-up in the international segment in
1QFY12 with order inflows (power T&D) from several Middle East geographies.
Note that L&T only announces its large orders and hence actual order inflows in 1QFY11 are
likely to be higher.
Stock prices reasonable stress case on earnings; could undershoot fair value
At about Rs1,450, the stock seems to price in a reasonable stress case scenario with
standalone EPS of about Rs70 for FY2013E at 15X P/E and subsidiaries valuation of
Rs400/share. Both these estimates are about 10% lower than our base case. This EPS would
result from 15% revenue growth in FY2013E post 19% in FY2012E and total of 180 bps
margins drop in two years. Rs400 of subsidiary valuation implies 2.7X the value of FY-11-
end invested equity in various subsidiaries.
This is versus our base case assumption of Rs77 EPS in FY2013E (implying a value of
Rs1,157/share based on 15X FY2013E EPS) and subsidiary valuation of Rs439/share.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Larsen & Toubro (LT)
Industrials
Better risk-reward; capex cycle, inflow quality & competition concerns continue.
The recent correction provides improves the risk-reward tradeoff (standalone at 13.5X
FY2013E P/E); nevertheless, we retain our REDUCE rating due to (1) weak capex cycle,
(2) quality of inflows (Rs200 bn+ may not be ready for execution) and (3) potential
disappointment (execution and margins) in near-term earnings, (4) increasing
competition across sectors. Inflow guidance is not key; quality (ready, margins and
Wcap) is key.
Much better risk-reward post recent correction; prices in reasonable stress case
The recent price correction (down 17% in the past three months) provides a better risk-reward
tradeoff for L&T. L&T (at Rs1,450/share, adjusted for Rs440/share for value from subsidiaries) is
trading at relatively attractive valuation of 13.5X FY2013E standalone EPS. At about Rs1,450, the
stock seems to price in a reasonable stress case scenario with standalone EPS of about Rs70 for
FY2013E at 15X P/E and subsidiaries valuation of Rs400/share (both 10% lower than our base
case). This EPS would result from 15% revenue growth in FY2013E post 19% in FY2012E and a
steep total of 180 bps margins drop in two years.
Inflow growth guidance may not be as important; quality (ready, margins, working capital) is key
There is some apprehension about L&T’s guidance at the end of 2Q, however, we would not be
overly concerned if guidance is lowered, as even flat (Rs800 bn) ordering would be enough to
maintain growth momentum. Execution readiness, margins and working capital are more
important for the order inflows. E.g. about Rs200 bn+ of orders in the past two years may not be
execution ready, apart from about Rs206 bn of orders from commercial and residential real estate.
There is a marginal risk of L&T downgrading revenue growth guidance from 25% as in FY2007
and FY2010, if on-ground execution is slower based on review of its business units performance
before 2Q results.
Retain REDUCE on weak capex cycle, potential disappointment and increasing competition
Our outlook for the stock is less negative, however, we are constrained to retain our REDUCE
rating on account of (1) weak capex cycle as reflected in various variables, (2) quality of order
booking (Rs200 bn+ may not be ready for execution), (3) potential disappointment in near-term
earnings performance versus reasonably high expectations, (4) potential for sharper-than-expected
margin contraction and (5) increasing competition across sectors along with clients breaking orders
in small parts reducing L&T’s size advantage. We revise our standalone (consolidated) estimates to
Rs69.3 (Rs79) and Rs77.1 (Rs91.7) from Rs69 (Rs79.6) and Rs82 (Rs98.2) for FY2012E and
FY2013E and correspondingly revise our target price to Rs1,625/share (from Rs1,800/share).
Order inflow growth may not be as relevant, while quality of inflows is key
We believe concerns related to potential miss of order inflow growth guidance may not be
as relevant. Even if the company reports no growth in order inflows in FY2012-13E (implying
inflows of about Rs800 bn each year), this would be sufficient to maintain a revenue growth
momentum of about 15-20% over the same period. The quality of order inflows (in terms of
potential margins, client profile etc) would be a more important factor to watch.
We build in relatively low order inflow growth assumption of only 2% in FY2012E versus
management guidance of 10-15% growth and about 7% in FY2013E.
Several orders may not be ready for execution in the near term
We note several orders to the tune of about Rs200 bn which may not be ready for execution
in the near term. These include in-house development projects such as Hyderabad Metro
project, BPP Tollway and Rajpura thermal power plant. Power equipment/ EPC orders (thirdparty)
may also face some delays as the sector is wrought with several challenges such as
environmental clearance issues, coal linkages etc.
Rs137 bn+ (about 15%) order inflows in FY2011 and FY12E have come in from the
industrial and commercial buildings segment, wherein execution may be slower than
expected.
Order inflows just about keeping pace
L&T has announced orders to the tune of about Rs40 bn post 1QFY12-end which leads to
total order inflows of about Rs210 bn in FY2012 so far (reported inflows of Rs162 bn in
1QFY12 + announcements post 1QFY12). These inflows were primarily led by the industrial
& commercial buildings segment, which contributed about Rs32 bn of the total inflow
announcements. The company had also seen a pick-up in the international segment in
1QFY12 with order inflows (power T&D) from several Middle East geographies.
Note that L&T only announces its large orders and hence actual order inflows in 1QFY11 are
likely to be higher.
Stock prices reasonable stress case on earnings; could undershoot fair value
At about Rs1,450, the stock seems to price in a reasonable stress case scenario with
standalone EPS of about Rs70 for FY2013E at 15X P/E and subsidiaries valuation of
Rs400/share. Both these estimates are about 10% lower than our base case. This EPS would
result from 15% revenue growth in FY2013E post 19% in FY2012E and total of 180 bps
margins drop in two years. Rs400 of subsidiary valuation implies 2.7X the value of FY-11-
end invested equity in various subsidiaries.
This is versus our base case assumption of Rs77 EPS in FY2013E (implying a value of
Rs1,157/share based on 15X FY2013E EPS) and subsidiary valuation of Rs439/share.
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