LARSEN & TUBRO LTD : BEST PLAY & GRAB AT EVERY DIPS !!!

Scrip Code: 500510 / LT

CMP:  Rs. 1484.95; Market Cap: Rs. 1,38,144.74 Cr; 52 Week High/Low: Rs. 1893.80 / Rs. 1401.00. 
Total Shares: 93,02,98,999 shares; Promoters : Not Defined – 00.00 %; Total Public holding 5 % or more : 34,09,54,585 shares – 36.65 %; Total Public holding 1 % or more : 41,41,62,953 shares – 44.52 %; Public holding : 17,51,81,461 shares – 18.83 %; Book Value: Rs. 398.31; Face Value: Rs. 2.00; EPS: Rs. 52.26; Dividend: 812.50 % ; P/E: 28.41 times; Ind. P/E: 16.72; EV/EBITDA: 18.27. Total Debt: Rs. 90,698.61 Cr; Enterprise Value: Rs. 2,22,997.45 Cr.

LARSEN & TOUBRO LTD: LARSEN & TOUBRO LTD was founded in 1938. Larsen & Toubro Limited operates as a technology, engineering, construction, and manufacturing company worldwide. Larsen’s divisions include Engineering and Construction Projects (E&C), Heavy Engineering (HED), Engineering Construction and Contracts (ECC), Electrical and Electronics (EBG), Machinery and Industrial Products (MIPD), and Information Technology & Engineering Services. These divisions undertake engineering design and construction of infrastructure and industrial projects, including civil, mechanical, and electrical & instrumentation engineering. The customer profile includes names, such as Samsung, Chevron, Bechtel, Kvaerner, Pirelli, Siam Michelin, and Goodyear. The Heavy Engineering (HED) division manufactures and supplies custom designed and engineered critical equipment and systems to the needs of core-sector industries and the defense sector. It is the preferred supplier of equipment for a select range of products, globally. The Division has entered into Shipbuilding business and engages in construction of specialty commercial vessels and warships for the navy, as well as the coast guard.  The Engineering Construction and Contracts (ECC) division delivers engineering, procurement, and contract solutions in the oil and gas, petrochemicals, power, and water space industries. The Electrical and Electronics (EBG) division offers solutions in low & medium voltage categories. Its businesses consists of switchgear, switchboards for different applications, including marine, meters, automation systems, petroleum dispensing pumps, medical equipment and tooling solutions and has operations at different locations in India (two in Mumbai and one each in Ahmednagar, Mysore, Faridabad and Coimbatore) and one unit for manufacturing operations in China. The Information Technology and Engineering Services Information and Technology Services division offers e-Engineering solutions, including product design and engineering analysis, engineering process support, production and plant engineering, asset information management, and design automation to high end technology verticals, such as automotive, aerospace, marine and ship design, plant engineering, and industrial products. This division also provides embedded systems and solutions comprising supply of hardware, application software, and enclosure design for electronics product design and development in automotive, medical, semiconductor, and industrial products. On November 30, 2009, Nuclear Power Corporation Of India Limited and Larsen & Toubro Ltd. announced the formation of a JV company to produce special steels and ultra-heavy forgings. On January 22, 2010, Larsen & Toubro Ltd. formed a JV with Sapuracrest Petroleum Bhd to undertake installation of pipelines and construction of offshore rigs and platforms in India, West Asia and South East Asia. In July 2012, L&T’s subsidiary Tamco Switchgear acquired Henikwon Corporation Sdn Bhd. L&T does business in Malaysia, the United States, the Unite Kingdom, Brazil, Saudi Arabia, the United Arab Emirates, Qatar, Bangladesh, and Sri Lanka. Larsen & Tubro Ltd is compared globally with Hyundai Development Company Ltd of South Korea, Daelim Industrial Company Ltd of South Korea, Nippo Corporation of Japan Ssangyong Engineering & Construction, Aker Solutions ASA and JTEKT Corporation.

Investment Rationale:

Larsen & Toubro is a major technology, engineering, construction, manufacturing and financial services conglomerate, with global operations. L&T addresses critical needs in key sectors - Hydrocarbon, Infrastructure, Power, Process Industries and Defense – for customers in over 30 countries around the world. L&T is engaged in core, high impact sectors of the economy and their integrated capabilities span the entire spectrum of ‘design to deliver’. With over 7 decades of a strong, customer focused approach and a continuous quest for world-class quality, L&T have unmatched expertise across Technology, Engineering, Construction, Infrastructure Projects and Manufacturing, and maintain a leadership in all their major lines of business. Every aspect of L&T's businesses is characterised by professionalism and high standards of corporate governance. Sustainability is embedded into our long-term strategy for growth. The Company’s manufacturing footprint extends across eight countries in addition to India. L&T has several international offices and a supply chain that extends around the globe. The Infrastructure spending in India as a percentage of GDP has declined meaningfully to just 3 % to 4 % from peak levels of 7 % to 8 %. And large projects in segments like urban infrastructure, water & irrigation, railways, and power T&D would pick up. The manufacturing segments like defence, power generation, and forgings provide strong opportunities. Another important driver is industrial capex – particularly hydrocarbons, metals, and fertilizers – both in India and overseas. L&T have received repeat orders from its loyal customers in the IT and residential business lines. Kannur and Cochin green field airports were secured during the year emphasizing its expertise in building aviation infrastructure. L&T also secured major orders from its esteemed customers like Bombay Realty, Omkar developers, Oberoi and DLF group for the construction of elite high rise residential towers in western and northern India. In southern India, prestigious orders were received from Prestige, Provident and Skylark group for the construction of residential towers. With the modernization of Tier 1 & 2 city airports and the kick start of Navi Mumbai green field airport will drive growth in domestic aviation sector. In the international arena, with falling oil prices, may have some impact on the Middle East economy, but there is hope that infrastructure spending will continue strongly in view of Expo 2020 (UAE) & FIFA 2022 (Qatar) and good business prospects are envisaged for Stadiums, Metro Rails and Healthcare related projects. The nuclear segment of the company is promising with the development-expansion of projects in existing locations like Kudankulam 3 & 4, Tarapur and Kalpakkam. Many new bridge projects in Western and Northern India, a few more special bridge packages from DFCC and High Speed Rail network are expected in India. L&T recently signed an MOU with the French firm Areva for cooperation to maximize localization for the 9000 MW Jaitapur Nuclear Plant in Maharashtra. L&T currently has a tall order backlog of more than Rs. 2.3 lakh crore, which is close to thrice its FY2015 revenue (excluding IT and finance businesses). Given the impeccable execution track record of L&T and average execution period of 24-30 months of the existing backlog, the revenue outlook remains very healthy. The management retains its guidance for an order inflow growth and revenue growth at 15 % for FY2016. It is expected that the ordering activities would shoot up once the domestic investment cycle revives and L&T is most suitably placed to capture opportunities owning to diversified presence, strong capability and healthy balance sheet. The management guides for a 100- basis point (BPS) year-on-year (Y-o-Y) margin expansion in FY2016 on the back of improvement in the performance of hydrocarbon business (worst is over) and stable margin in the infrastructure business; therefore, healthy bottom-line growth to follow too. Recently, Bain Capital bought 85.2 million shares, or a 4.95 % stake, in L&T Finance from parent firm L&T through an open market transaction. The share sale was via exchanges and was concluded at an average price of Rs.70 per share, implying a deal size of Rs. 597 crore. L&T will reduce its stake in L&T Finance to about 62.5 % following the conversion of the warrants. L&T has so far held 72.5 % in its finance subsidiary. In addition to that , L&T’s buildings & factories segment has secured an order worth Rs. 740 crore for construction of a commercial complex in Gurgaon, which is scheduled to be completed in 24 months. In water & effluent treatment business, it received a water supply order of Rs. 573 crore from the rural water supply & sanitation department, Telangana. Its power transmission & distribution segment has secured a turnkey order worth Rs. 192 crore from the Transmission Corporation of Telangana for supply, erection, testing and commissioning of a 400 kV quad moose double circuit transmission line which will run across Adilabad and Karimnagar districts of Telangana. Also, L&T’s subsidiary has received from Delhi Metro Rail Corporation for the supply, installation, testing and commissioning of ballast-less track of standard gauge. Additional orders, across businesses of L&T Construction, have also been received from various ongoing jobs. L&T is going for listing of its IT subsidiary: L&T Infotech by offering 15 % stake in the proposed IPO, which could unlock value. The IT subsidiary is growing at 20 % growth rate currently with a fairly high base and is having earnings before interest, tax, depreciation and amortisation (EBITDA) margin profile of around 20 %. This along with the strong pedigree makes a case for relatively premium valuation for L&T Infotech. Moreover, the company is constantly looking for other value unlocking opportunities to fund its future growth in the core engineering business. As investment cycle in India is reversing after a long; the addressable order prospect for L&T is estimated to be above Rs. 5 lakh crore in future, considering the potential revival in the domestic investment cycle ahead. While investments in road and power transmission are going on currently, large investments in railways and water segment are expected to start soon. Nevertheless, the outlook for L&T’s three other segments (hydrocarbon, metallurgical and power) are expected to remain weak for some time.

Outlook and Valuation:

Larsen & Toubro’s (L&T) is a USD 15 billion technology, engineering, construction, projects, manufacturing and financial services conglomerate, with global operations. The company is engaged in core, high-impact sectors – infrastructure, construction, defence, hydrocarbon, heavy engineering, power, aerospace, shipbuilding, electrical & automation, mining and metallurgy. Its integrated capabilities span the entire spectrum of 'design-to-deliver', and it offers turnkey EPC solutions in its major business lines. Its track record covers products, projects and processes executed to international benchmarks. Every aspect of L&T's businesses is characterized by professionalism and high standards of corporate governance. Sustainability is embedded into its long-term strategy for growth. The Company's manufacturing footprint extends across multiple countries in addition to India. L&T has several international offices and a supply chain that extends around the globe. It has projects like Airports in India and the Middle East Metro rail systems for Riyadh, Qatar and major Indian cities. Projects in large infrastructure include bridges and highways - from Jordan to Malaysia. In Technology, L&T is contributing to key missions like the building of India's first nuclear-powered submarine, maiden missions to the moon and Mars. For Hydrocarbon projects in the Middle East, Africa, South East Asia and India, L&T is building the world's longest heated and insulated oil pipeline. Also building the world's largest coal gasifier made in India and exported to China. L&T has continuously evolved by building new skill sets and competencies to effectively benefit from emerging trends, and hence L&T focuses on Portfolio rationalization. L&T has incubated and grown service businesses like IT and finance on a wide range. It is also expanding the share of manufacturing businesses like power BTG, defence, and forgings, by creating independent companies for different businesses and listing subsidiaries, it has kept business structure simple and promoted managerial talent. Also L&T is attempting to correct capital allocation through various initiatives & focusing on improving RoE through monetization of mature assets, exiting non-core activities, and fund infusion (including listing of subsidiaries) and this will improve its consolidated RoE. L&T has invested near about Rs. 100b in setting up manufacturing businesses for defense, power BTG, forgings, which are difficult to replicate and this will position L&T as a dominant player. The Indian capex cycle is believed to be on recovery mode. The recent burst of policy measures would ease environment for capex. This will call economists to cut rates, and will give thrusts to stronger recovery of Capex and a full-fledged recovery will be seen only in FY2017. The slowdown in order inflows from the Middle East markets coupled with revival in domestic capex cycle should lead to a shift in the order inflow mix more towards the domestic markets, going forward. On the back of shift in order book towards domestic markets, there could be a uptick in execution. Accordingly, L&T could have a 16.2 % top-line CAGR over FY2015-2017E. Given that L&T is currently sitting on an order book which gives revenue visibility for over 30 months, this shift in order inflow mix should help the company in faster margin recovery, expanding its EBITDA margins by 0.32 % during FY2015-17 to 11.7 %. The company retained its guidance on both revenue and order intake growth at 15 % for FY16, while EBITDA margins are expected to rise by 100bp (ex-services business) on account of loss avoidance from the hydrocarbons business. Core E&C revenue could double over the next three years, as domestic intake in FY15 was INR943b while revenue was INR460b. The Portfolio churn’ in concession portfolio and service segments would aid value unlocking as L&T Infotech & Tech Services IPO is being expected by July 2016. On Financial side the Q1FY16 Standalone revenue of L&T grew 4 % YoY to Rs. 1,0710 crore. Its Infrastructure segment posted strong revenue growth of 16 % YoY while power segment, after many quarters of decline, grew 12 % YoY in Q1FY16. In Q1FY16, the hydrocarbons segment reported a robust 41 % jump in revenues coupled with positive 4 % EBITDA margin. L&T recorded a 21 % YoY decline in consolidated order inflows given the high base of order intake in Q1FY5. Hence, order inflows for Q1FY16 were at Rs. 26376 crore. The order backlog as of Q1FY16 stood at Rs. 2,39,000 crore, up 22 % YoY. Order inflows have perked up in FY15 (Rs 1.4tn, up 19 % YoY) and consolidated order backlog is up 28 % YoY to Rs 2.3tn. With an expected pickup in domestic projects execution management has guided for 15 % growth in consolidated order inflow & revenue for FY16. L&T is very well positioned to benefit from gradual recovery in the domestic capex cycle, given its diverse range of sectoral exposure, strong balance sheet and better cash flow generating potential in comparison to its peers, which are struggling with higher leverage, and strained cash flows. L&T is an established leader with excellent execution track record over many business cycles. And L&T remains the best proxy to investment revival in India. Hydrocarbon business should also come out of red in FY16 as the company has finished losses on low margin legacy orders. At the current market price of Rs. 1,484.95, the stock is trading at a PE of 25.91 x FY16E and 20.39 x FY17E respectively. The company can post Earnings per share (EPS) of Rs. 57.30 in FY16E and Rs. 72.80 in FY17E. The fair value of L&T on stand-alone basis using SOTP comes at Rs. 1,880 per share, while the valuation of its investments in subsidiaries comes at Rs. 408.12 per share. It is expected that the company’s surplus scenario is likely to continue for the next three years keeping its growth story in the coming quarters also. 

SOTP Valuation :-

Business Subsidiary	Value Per Share (in  ₹ Rs.)
L&T Core Business	1,470.00
L&T Hydrocarbons	16.00
L&T Infotech	137.00
L&T Finance*	76.12
Infra Development projects	69.00
Power Development projects	37.00
Power Equipments Venture	7.00
Shipbuilding & Container Port	23.00
Sp. Steel & Heavy Forging Venture	9.00
Other Investments	34.00
TOTAL	1,878.12

*Note: L&T holding in L&T Finance is reduced to 62.5 %.

KEY FINANCIALS	FY14	FY15	FY16E	FY17E
SALES (₹ Crs)	56,598.89	57,017.40	65,529.90	78,635.80
NET PROFIT (₹ Cr)	5,493.10	5,056.20	5,329.20	6,768.90
EPS (₹)	52.90	50.60	57.30	72.80
PE (x)	30.70	29.10	30.22	24.10
P/BV (x)	4.00	3.70	3.40	3.10
EV/EBITDA (x)	20.80	18.80	18.90	15.20
ROE (%)	12.80	13.20	11.70	13.60
ROCE (%)	9.00	8.00	7.60	8.90

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*As the author of this blog I disclose that I do not hold LARSEN & TUBRO Ltd in my any of the portfolios.

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