Core business growth and gains from subsidiaries propel L&T

Core business growth and gains from subsidiaries propel L&T

For Larsen and Toubro Ltd (L&T), the better-than- expected FY11 guidance sets the tone for growth acceleration over FY11-12. Driven by 25% order intake guidance in FY11, we upgrade FY12 revenue estimates by 5%. Though maintaining margins at FY10 levels would be a challenge, margin erosion would be contained to 50-100 basis points (bps).

The company’s balance sheet remains strong with net debt-equity ratio at -0.1. Current, liquidity of Rs9,400 crore is sufficient to fund investment plans over the next two-three years. Buy-back of minorities in the infrastructure subsidiary, Infrastructure Development Projects Ltd, should increase flexibility to infuse capital for stronger growth in the asset portfolio. Driven by 8% upgrade to our FY12 earnings estimate, we increase our target price to Rs1,822 and reiterate buy.

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On top of 35% year-on-year (y-o-y) order intake growth (higher end of the guidance) in FY10, the company has guided for 25% order inflow growth in FY11, driven by continued buoyancy in hydrocarbon, power, infrastructure and real estate sectors. The company also indicated that industrial capital expenditure recovery is gradually taking root. In addition, higher pre-qualifications in West Asia and opportunities in South-East Asia should help overseas order booking.

Though the average execution cycle would increase as the proportion of power orders in the order book rises, return of short-cycle industrial orders would aid execution. The lengthening execution cycle is factored in our estimates—we model an execution rate of 40% in FY12 against 52% in FY10 and 64% in FY09.

The FY10 earnings before interest, tax, depreciation and amortization (Ebitda) margin was helped by lower input costs and the company admitted that it would be a challenge to maintain margins at the current levels. However, the company categorically stated that fears of margin erosion on account of power sector orders are unfounded. We model 11.6% Ebitda margin for FY11-12—a 100 bps contraction, which is the lower end of margin guidance.

The fourth quarter witnessed the highest-ever order intake of Rs23,800 crore, aided by orders from upstream and downstream hydrocarbon sector; power generation and transmission and distribution; and strong recovery in award activity by the real estate sector. Award activity from the metals sector was also robust during the quarter.

The company has guided for 25% y-o-y order inflow growth in FY11, driven by continued buoyancy in the above sectors and gradual pick-up in the industrial sector. The management also remained optimistic on revival in export markets, which were muted during the year. The optimism stems from higher pre-qualifications in most of West Asian countries and emerging opportunities in South-East Asia.

The recurring consolidated earnings per share, at Rs63.60, for the last fiscal was higher than our estimate. Consolidated profit after tax increased 26% y-o-y to Rs3,997 crore—that’s Rs320 crore higher than our estimate. Only one-third of the variance is explained by the positive surprise in parent earnings.

Though the company did not share full details of the various subsidiaries, we believe the improved performance has resulted from higher-than-estimated profits at TAMCO, the Malaysian electrical company, Omani shipyard, and possibly lower-than-forecast losses in the power equipment joint ventures (JVs).

The management stated that power equipment JVs would operate at approximately 6% Ebitda margins during the commencement phase. Margins would reach double-digit levels in two years, when the management intends to increase indigenization levels to 80%.

The finance subsidiaries witnessed strong growth in their loan books. L&T Finance Ltd’s revenue grew 24% y-o-y in FY10, driven by rural equipment finance and microfinance segments. Net profit growth was faster at 58% y-o-y, driven by higher net interest margin. Business assets as on end-FY10 stood at Rs7,000 crore.

L&T Infrastructure Finance Co. Ltd also posted robust results. Income rose 53% y-o-y in FY10, driven by higher lending to most infrastructure segments. Business assets as on end-FY10 stood at Rs4,300 crore.

Graphic by Naveen Kumar Saini/Mint