Larsen & Toubro (L&T)

Though L&T’s operating margin is under pressure, the longterm fundamentals are firm. Investors may consider taking exposure in the stock with a long-term view

Larsen & Toubro (L&T) is a leading player in the Indian capital goods space. Its stock has been badly hit last year. The company’s market capitalisation fell by nearly 60% compared to a 50% fall in the Sensex in the same period. However, L&T’s 2-year and 3-year returns are still better than the Sensex, and with a longer-term perspective, the stock is promising. This is backed by the fact that though infrastructure seems to have lost its flavour among the investors now, it is going to remain a key to the country’s growth.

Further, the company has taken concrete steps over the last two years to expand its areas of operations. The stock is a good buying proposition and investors may accumulate the stock with a long-term view.

BUSINESS:

L&T’s business spans across fairly large areas of operations. The three major business segments are: engineering & construction, electrical & electronics and machinery & industrial products. The first segment accounts for nearly 75% of its revenues, and the other two segments contribute the rest. Total order book position stands at Rs 63,000 crore as on September ‘08, up by 59% over last year and is almost two-and-a-half times its trailing four quarters sales ended September ‘08.

The company plans to develop its businesses as separate entities to enable faster execution and bring in flexibility. With that aim, it is planning to create 12 operating companies within the existing company. With average revenues of about Rs 2,000 crore for each operating unit, this looks quite acceptable. L&T has also sold off its ready mix concrete unit earlier this financial year, where it had about 25% market share.

FINANCIALS:

For the quarter ended September ‘08, the company recorded sales growth of nearly 40%, and its net profit grew 32%. Cost of inputs, including purchased goods, grew 24%, significantly lower than sales growth. While a sharp rise of 62% in other expenses reduced the growth in operating margin. However, this expense may remain low for the December ‘08 quarter, improving the operating margin further. While at the operating level, the performance was reasonable, interest and depreciation cost together more than doubled and now account nearly 17% of its operating cost, up from 10% last year. With increase in debt, these costs will remain high over the next few quarters.

Over the last six quarters, the company has shown average sales growth of 43%, operating profit growth of 54% and net profit growth of 59%. While profit growth rate has now come down to 30-35% level, it is still significant, and now with easing of raw material and crude prices, it can move up a notch or two.

OUTLOOK:

L&T has entered into ship-building industry. It has set up of a shipyard in Tamil Nadu, and has the capacity to build complex ships and very large crude carriers. The company has also won some orders for construction of ships. Moreover, the company has tied-up with some global companies in the power sector to manufacture heavy machinery for generating power. The company is also looking to enter the power generation sector, but that may take time to yield results. The stock is currently trading at a PE of about 17, the lowest over the last four years. Its P/E took a beating in the aftermath of the Satyam Computer crisis. The ratio of L&T’s P/E to Sensex P/E is at its lowest since October ‘05, though the relative growth prospect favours L&T.

LOOKING UP

• L&T has a capex of Rs 1,500 crore during FY09 and FY10 each
• The company is continuously expanding and upgrading its existing manufacturing facility
• Engineering & construction business accounts for 75% of its revenues
• There is a move to increase its footprint across international operations. It’s focussing on West Asia. L&T is setting up of joint ventures and execution centres in these regions
• In the last six quarters L&T has maintained an average growth of 43% in sales, 54% in operating profit and 59% in net profit
• L&T’s stock is currently trading at a PE of about 17.5, lowest in the last four years
• There is a clear focus to exit non-core business and to provide operational freedom to core businesses. It has already sold its ready mix concrete unit earlier this financial year
  

Beta: 1.06
Institutional holding: 51.06
Current dividend yield: 2.43
Current P/E (standalone): 17.5
Current m-cap: Rs 42,151cr