Larsen & Toubro- Realty tremors provide entry point: Macquarie Research

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Larsen & Toubro
Realty tremors provide entry point
Event
 L&T stock has corrected by 5% over the last two days and following the news of
so-called housing finance scam and involvement of Mumbai-based real estate
companies. We met the management and return confident that the correction is
unwarranted as L&T has miniscule exposure to the realty market in Mumbai.
We retain our Outperform rating on L&T with a target price of Rs2,260.


Impact
 Minimal exposure to Mumbai real estate companies: Real estate
construction accounts for 5-6% of the total order book of Rs1.15tn. This
includes residential and commercial real estate projects. Exposure to Mumbai
real estate would be limited to 2–3% of the overall order book.
 A large portion of Mumbai orders are from Oberoi Realty (OBER IN, Rs263,
Not rated). OBER is debt-free with its entire land bank already paid for.
Similarly, DB Realty (DBRL IN, Rs233, Outperform, TP: Rs409, Unmesh
Sharma) is also a zero debt company. This gives us confidence that
collateral damage, if any, from real estate issues would be very limited.
 Execution to continue to ramp up from current levels: Domestic E&C
revenues increased 26% YoY in 1HFY11. Management expects the growth
momentum to continue in 2HFY11 as well. We believe L&T is well-positioned
to deliver its guidance of 20% revenue growth in FY11. Once the overseas
construction revenues stabilise, the growth could be even higher.
 Monetisation of L&T financial subsidiaries to happen soon: L&T has filed
a DRHP for the IPO of L&T Finance Holdings (which houses its financial
subsidiaries) with the SEBI on 29 September. We expect the IPO to be
completed in 4QFY11. Fund raising in L&T Finance Holdings will reduce the
capital support requirement from parent L&T.

Earnings and target price revision
 No change.

Price catalyst
 12-month price target: Rs2,260.00 based on a Sum of Parts methodology.
 Catalyst: large order wins and further pickup in execution.

Action and recommendation
 Earnings upgrade cycle still in favour of L&T: We believe that earnings
upgrade cycle is still intact for L&T. We see upside risks to consensus
estimates primarily on account of higher margins. Consensus is building in
margin decline of 20bps and 40bps in FY11 and FY12 respectively despite an
expansion of 110bps in 1HFY11.
 Valuations reasonable at 17.5x FY12: L&T is trading at 17.5x FY12 core
earnings (adjusted for subsidiary valuations) with earnings CAGR of 25% over
FY11–13.
 Maintain L&T as our favoured pick in Indian E&C space: We believe that
the current correction in L&T is unwarranted and should be used as a buying
opportunity. L&T would be a key beneficiary of the pickup in capex cycle in
India. We maintain our Outperform rating on the stock with a target price of
Rs2,260.