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Larsen & Toubro Ltd. (LT) - Co. Report - Dtd. - February 12, 2013




Axis Capital Limited


13 Feb 2013





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We met key decision makers across a spectrum of capital intensive sectors over the last three months to gauge their investment plans. Our major findings were that the current drivers of Capex have weakened dramatically – Power (Generation & Transmission), Metals and Roads. However, these would be more than offset by new mega drivers, led largely by the public sector over the next 3 years. This is due to fundamental enablers in their policy/ financing mechanisms which have already been implemented – Railways (tariff hike+ DFC+ Metro), Oil & Gas (largely RIL & ONGC), and Power Distribution (SEB debt restructuring). Thus, the total of orders from the above major (prior and future) sectors was Rs ~4 trn p.a. in FY07-10. This plummeted to Rs 3 trn p.a. in FY10-13E, and is set to rebound to Rs 4 trn p.a. again in FY13-16. In this report, we have done a bottom-up exercise across these sectors, using the insights and plans from these meetings, to validate the above figures. The major beneficiary of this trend would be L&T. Hence we are enclosing 2 reports simultaneously here – on India Capex and on L&T. L&T would re-rate before earnings growth rebounds  Domestic order inflow (down 19% YoY in FY12) has turned around from FY13, driven by real estate projects, which Street suspects are low margin  From FY14, we expect demand to emanate from complex sectors where L&T has been traditionally strong and enjoy better margins, such as Oil & Gas, Fertilizers and Railways. These will account for 30% of total order intake from FY14 v/s 10% currently  We forecast 15% order inflow CAGR (FY13-15) which is conservative given that we have assumed flat-to-declining orders from international (20% of orders), buildings & factories (30% of orders) and roads (12% of orders)  While headline margins would decrease by 50 bps to 11% in FY14-15E (low margin orders taken during FY12-13 get executed), they would revert to >12% from FY16 as these high margin orders kick in  Though earnings may not excite in the near term, we believe the market is bound to take cognizance of improving order flow mix and balance sheet (through reducing working capital and lower investments in BOT). Consequently, we expect RoCE to improve to 18% by FY15 vs. 16% currently. This, along with diminishing concerns on leadership and capital allocation would drive L&T’s re-rating. Accordingly, we have assigned 16x core FY15E EPS of Rs 90 to arrive at our SOTP-based target price of Rs 1,886. Our TP implies 26% upside from CMP of Rs 1,495. Reiterate BUY  At CMP, the stock trades at PE of 14x FY14E core EPS of Rs 77 (excluding dividend income from subsidiaries) and 12x FY15E core EPS of Rs 90. (adj. for VoI of Rs 441) Enclosed please find our exhaustive bottom-up India Capex report, along with an updated L&T report. Regards, Bhavin Vithlani (Executive Director – Power & Cap Goods) Institutional Equity Research Axis Capital Ltd. Tel: +91 22 43251144 Charanjit Singh (Vice President – Capital Goods) Institutional Equity Research Axis Capital Ltd. Tel: +91 22 43251123

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