L&T defers capacity expansion; doesn't bode well: Kotak Sec

Visit http://indiaer.blogspot.com/ for complete details �� ��


Industrials
India
L&T defers capacity expansion; doesn't bode well, particularly for new entrants.
L&T has indicated that it intends to defer its power equipment capacity expansion plans
and is apprehensive of utilization levels of the current 4 GW installed capacity. L&T may
be posturing for duty on imported equipment in light of orders from RPower, Lanco.
We believe that total power equipment market may be to the tune of ~20 GW p.a.
which may be suboptimal for most new entrants as well as being challenging for BHEL.




L&T defers capex plans for power equipment on apprehension of utilizing current capacity
L&T has deferred its power equipment manufacturing venture beyond the already established
capacity of 4,000 GW. The management cited apprehensions on utilizing the exiting set-up
capacity itself. L&T had earlier planned to increase its equipment manufacturing capacity to 6,000
MW post establishing the first phase of capacity (of 4,000 MW). The company has 7.4 GW of
equipment orders (of which 2.1 GW is in-house) while it should have had about 10-12 GW of
orders by now for optimum utilization of the capacity.

May be posturing for import duty, but a warning nevertheless; duty critical for business build-up
While L&T might be posturing for application of import duty on power equipment (especially from
China), however, such an aggressive pitch for duty imposition implies that imposition of duty is
critical for business build-up. Recent large orders to Chinese equipment manufacturers Harbin and
Shanghai Electric by Lanco and Reliance Power have brought the issue under sharper focus.

Market size of 20 GW p.a. also may be sub-optimal for new entrants; challenging break-even
We believe that the power equipment business may have a total market size of about 20 GW per
annum. This may be sub-optimal for new entrants with a potential market of only 2-3 GW for new
entrants combined (assuming 10-13 GW goes to BHEL, 3-4 GW to L&T and 2-3 GW to Chinese
players). The challenge may be steeper for players like BGR that are committing high capex as
breakeven sales may not be achieved; needs annual sales of 2.6 GW for a pre-tax RoCE of 12%.

Similar large-scale expansion in T&D and subsequent demand slowdown led to immense pressure
The reported capacity of eight transformer manufacturers more than doubled (110% growth) to
187,000 MVA over FY2007-10 versus a production growth of about 65% over the same period.
This led to a drop in capacity utilization to 63% from 80% leading to strong pressure on
realization and margins for T&D equipment companies.

Cut BHEL TP to Rs2,500 (retain REDUCE), BGR TP to Rs860; top picks: Thermax, Crompton, L&T
We cut our TP on BHEL to Rs2,500 (from Rs2,600) based on lower P/E multiple of 18X FY12E EPS.
Retain REDUCE on rising competition threatening market share, margins and order inflows likely to
lag execution. Cut TP on BGR to Rs860 (from Rs950)—exclude value from power equip. venture.
Our top picks in the industrials segment include (1) Thermax on strong expansion of business
opportunity, strong balance sheet, and among the best positioned to benefit from capex recovery,
(2) Crompton: Pick-up in overseas business, likely strong near-term growth and strong cash
generation and (3) L&T on scale-up of power equipment business, capex revival, value creation in
subsidiaries and strong balance sheet.