Larsen & Toubro - Risk to guidance and earnings may de-rate; Cut to Neutral :: BofA Merrill Lynch

   
Risk to guidance and earnings
may de-rate; Cut to Neutral
„The going gets tough: Down to a non-consensus Neutral
We cut L&T from Buy to Neutral. We see risks of a de-rating in its core business
led by – 1. Likely miss in FY12 order inflow guidance on loss of big-ticket orders in
power and metal & low business confidence in India (below 2009!), 2. Weaker EPS
growth and 3. RoE decline on shift in its business model to developer. Our SOTP
based PO falls to Rs1,660 ($33.90/ADR), reflecting our EPS cuts of 9-17% and
de-rating. The stock has fallen 25% (3 mos), underperformed the market by 11%
YTD and potential stake sale in Subs. may limit downside. But we see upside
potential capped and risks to bullish consensus (35 of 42 analysts rate it Buy).
Guidance at risk as orders lost; Weak macro to slow capex
L&T could miss its FY12 order inflow guidance of 15-20% significantly (our est. 5%)
due to tough competition and low business confidence. EPS would hurt if slowmoving orders (10% of backlog) in steel/power/realty are cancelled – possible, as
we see the business environment uncertainties hurting the corporate capex cycle.
Slowing earnings, Peaking RoE: Stock may de-rate
A proxy to India’s infra & industrial capex, L&T has enjoyed premium multiples.
However, the stock may de-rate here on, as we see the firm’s FY11-14E EPS
CAGR slowing to 15% vs 19% during FY08-11. Its RoE likely decline due to the
capex in lower-RoE infra assets – Utility, Hyd. Metro (21% of FY14E capital
employed) and stranded capacities at shipyard & Nuke forging on lack of orders.
Street seems too bullish, we are 5-8% below on EPS
With >80% analysts rating L&T as a Buy (average PO: Rs1,874), expectations are
a tad high, in our view. Our new PO is 11% below consensus PO and our parent
EPS are 5-8% below consensus – reflecting our perception of downside risks