L&T’s business to improve over the years

L&T’s business to improve over the years

Larsen and Toubro Ltd’s (L&T) order intake during year-to-date FY10 has been disappointing in most business segments. The power equipment segment, which has witnessed strong traction (expect about 30% contribution to the overall order intake in FY10), is an exception. However, as power equipment projects entail long gestation and L&T recognizes margins only after completing 25% of the project, we expect initial margins on these projects to be accounted only from FY13.

The increased order intake in FY10 is unlikely to result in higher revenues and margin recognition in FY11-12.

We expect L&T’s power equipment joint venture (JV) with Mitsubishi Heavy Industries Ltd to report losses of Rs230 crore in FY11 and Rs270 crore in FY12. L&T has 51% stake in the JV, implying that its share in the losses would be Rs120 crore and Rs140 crore, respectively.

The power equipment projects are likely to cross the margin recognition threshold of 25% project completion in FY13. Hence, we believe that the inflexion point in terms of earnings contribution from subsidiaries will come only in FY13-14.

Unlike several of its peers, L&T is continuously developing new skill sets, entering new segments and geographies. We believe that its entry into new areas such as power equipment, nuclear power plants, defence, shipbuilding, power development projects, and forgings (thermal and nuclear), increased presence in West Asia, and its ability to take new public-private partnership projects (due to a strong balance sheet) will help L&T ensure long-term sustainability of order flow. Further, some of these business segments could contribute meaningfully to consolidated revenues and profitability.

We now expect L&T to report a consolidated net profit of Rs3,450 crore in FY10 (up 14.9%), Rs4,040 crore in FY11 (up 17%) and Rs5,160 crore in FY12 (up 27.9%). Our sum-of-the-parts-based target price is Rs1,617 per share. We maintain a neutral view on the stock.