Action: Visibility remains strong, diversified presence should benefit
order inflows; reiterate BUY
L&T guides for 15% y-y order inflow growth in FY12F. Even if there is
minor slippage in these numbers, there would be little impact on L&T’s
FY12-13F earnings in our view, as the order backlog at 3x TTM provides
strong visibility to medium-term growth. Pick up in the execution of long
gestation projects in recent quarters augurs well for revenue growth. We
expect revenue growth of 25% p.a. over FY12-13F. Margin booking on
crossing threshold and a potential fall in commodity prices should benefit
margins, we expect. L&T’s diversified presence across segments (unlike
BHEL) reduces concentration risk. Listing of subsidiaries should lead to
value unlocking and further strengthen the balance sheet, in our view.
Key Catalysts
Improvement in the macro environment, such as peaking interest rates,
falling inflation and advancements in policies related to infrastructure
investment, and value unlocking in subsidiaries.
Valuation: Trading below normal valuation range; stock pricing in
order inflow slippage and decline in profitability levels
We believe LT should trade at 15-20x one-yr fwd earnings. The stock is
trading at 14.7x one-yr fwd adj P/E (adj for subsidiary valuations), which
we think already prices in anticipated slippages in order inflows and a
decline in profitability over a period of time. LT is our top pick in the largecap
infra space, given its diversified presence, strong competitive position
and attractive valuation. Prefer LT over BHEL.
Moderate growth and profitability priced in
L&T has corrected by 28% YTD and 16% over the past 12 trading days. We attribute this
to concerns over order inflows and profitability. There has been some disappointment in
order inflows for L&T vs our and market expectations in recent weeks, primarily
regarding the NTPC bulk tender. This could result in L&T missing the lower-end of its
guidance for FY12F order inflows by INR 50-55bn, in our view. Even order inflow in
1QFY12 was low at INR160bn against our expectation of INR200bn. Order inflow growth
at 4% y-y in 1QFY12 implies a 55-60% increase from 1Q levels to meet management
guidance of 15-20% growth. We are factoring in 13% y-y growth in FY12F, assuming
slippage in company guidance. The stock’s recent underperformance indicates that order
inflow disappointment has been factored in to a large extent, in our view.
Moderation in profitability has been the other concern. Incremental investments into
power generation equipment, shipbuilding and development projects could yield lower
returns, owing to overcapacity and high competition .Core EBITDA margin in 1QFY12
dropped to 11.9%, 89bps below the 1QFY11 margin. EBITDA margin fell y-y in 1QFY12
for the first time in 9 years, raising concerns about a fall in ROE over the long term. We
see limited margin downside going forward, as projects cross thresholds for margin
booking. Furthermore, a drop in commodity prices should assist margins, we believe.
Valuation attractive
We believe, excluding periodic aberrations, the trading range for L&T has been stable at
15-25x one-year forward earnings. We maintain that in a scenario with delays in policy
decisions, increase in interest rates and tightening liquidity, L&T would trade at the lower
end of this range at 15-20x. We value the parent business at the midpoint of 17.5x
FY13F earnings to arrive at a one-year forward value of INR1,565/sh.
Our IT team values mid-cap IT stocks at 12x FY13F earnings, which implies ~14x FY12F
earnings. We value L&T Infotech in line with its other mid-cap peers at 14x FY12F
earnings. This implies a valuation of INR51.7bn, implying INR83/sh. We value the two
financial services subsidiaries at 2x book, in line with the current market cap of L&T
Finance Holdings. Our valuation for the two entities combined is INR66bn, implying
INR107/sh.
We value the infra development subs at 2x equity invested at the end of FY12F. We
believe that some of the developmental assets such as the Dhamra port and the older
roads deserve a multiple greater than 2x. Given higher competitive intensity, we prefer to
be conservative on our return assumption for some of the newer assets such as
Hyderabad metro and the recently won roads. Overall, we reckon that the valuation of 2x
FY12F book is justified given the execution capabilities and financial strength of L&T,
and the likelihood that the infra development subsidiary will trade at higher end relative
to peers, which are trading at 1.5-2x FY12F book.
order inflows; reiterate BUY
L&T guides for 15% y-y order inflow growth in FY12F. Even if there is
minor slippage in these numbers, there would be little impact on L&T’s
FY12-13F earnings in our view, as the order backlog at 3x TTM provides
strong visibility to medium-term growth. Pick up in the execution of long
gestation projects in recent quarters augurs well for revenue growth. We
expect revenue growth of 25% p.a. over FY12-13F. Margin booking on
crossing threshold and a potential fall in commodity prices should benefit
margins, we expect. L&T’s diversified presence across segments (unlike
BHEL) reduces concentration risk. Listing of subsidiaries should lead to
value unlocking and further strengthen the balance sheet, in our view.
Key Catalysts
Improvement in the macro environment, such as peaking interest rates,
falling inflation and advancements in policies related to infrastructure
investment, and value unlocking in subsidiaries.
Valuation: Trading below normal valuation range; stock pricing in
order inflow slippage and decline in profitability levels
We believe LT should trade at 15-20x one-yr fwd earnings. The stock is
trading at 14.7x one-yr fwd adj P/E (adj for subsidiary valuations), which
we think already prices in anticipated slippages in order inflows and a
decline in profitability over a period of time. LT is our top pick in the largecap
infra space, given its diversified presence, strong competitive position
and attractive valuation. Prefer LT over BHEL.
Moderate growth and profitability priced in
L&T has corrected by 28% YTD and 16% over the past 12 trading days. We attribute this
to concerns over order inflows and profitability. There has been some disappointment in
order inflows for L&T vs our and market expectations in recent weeks, primarily
regarding the NTPC bulk tender. This could result in L&T missing the lower-end of its
guidance for FY12F order inflows by INR 50-55bn, in our view. Even order inflow in
1QFY12 was low at INR160bn against our expectation of INR200bn. Order inflow growth
at 4% y-y in 1QFY12 implies a 55-60% increase from 1Q levels to meet management
guidance of 15-20% growth. We are factoring in 13% y-y growth in FY12F, assuming
slippage in company guidance. The stock’s recent underperformance indicates that order
inflow disappointment has been factored in to a large extent, in our view.
Moderation in profitability has been the other concern. Incremental investments into
power generation equipment, shipbuilding and development projects could yield lower
returns, owing to overcapacity and high competition .Core EBITDA margin in 1QFY12
dropped to 11.9%, 89bps below the 1QFY11 margin. EBITDA margin fell y-y in 1QFY12
for the first time in 9 years, raising concerns about a fall in ROE over the long term. We
see limited margin downside going forward, as projects cross thresholds for margin
booking. Furthermore, a drop in commodity prices should assist margins, we believe.
Valuation attractive
We believe, excluding periodic aberrations, the trading range for L&T has been stable at
15-25x one-year forward earnings. We maintain that in a scenario with delays in policy
decisions, increase in interest rates and tightening liquidity, L&T would trade at the lower
end of this range at 15-20x. We value the parent business at the midpoint of 17.5x
FY13F earnings to arrive at a one-year forward value of INR1,565/sh.
Our IT team values mid-cap IT stocks at 12x FY13F earnings, which implies ~14x FY12F
earnings. We value L&T Infotech in line with its other mid-cap peers at 14x FY12F
earnings. This implies a valuation of INR51.7bn, implying INR83/sh. We value the two
financial services subsidiaries at 2x book, in line with the current market cap of L&T
Finance Holdings. Our valuation for the two entities combined is INR66bn, implying
INR107/sh.
We value the infra development subs at 2x equity invested at the end of FY12F. We
believe that some of the developmental assets such as the Dhamra port and the older
roads deserve a multiple greater than 2x. Given higher competitive intensity, we prefer to
be conservative on our return assumption for some of the newer assets such as
Hyderabad metro and the recently won roads. Overall, we reckon that the valuation of 2x
FY12F book is justified given the execution capabilities and financial strength of L&T,
and the likelihood that the infra development subsidiary will trade at higher end relative
to peers, which are trading at 1.5-2x FY12F book.
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