Motilal Oswal is bullish on Larsen and Toubro (L&T) and has recommended buy rating on the stock with a target of Rs 1670 in its June 21, 2012 research report.
Over the years, LT has continuously evolved through building new skill sets and competencies to effectively benefit from emerging trends and opportunities through out economic cycles in several business/geographic segments. LT has acquired higher adaptability, enabling it to seize macro opportunities and weather volatility better than its peers. In the last few years, Buildings & Factories, Process Industries and Power have been the key growth drivers while, Overseas Markets, Urban Infrastructure and Railways are likely to emerge as key growth drivers.
LT had instituted a very strong risk management process in 2005, which led to a structural change in reported margins (from 7-8% to 12-13%), driven by tight control on project profitability and cash flows. LT has preferred to withdraw rather than bid aggressively to win orders at the cost of margins. The company has maintained tight control over net working capital (just 10% of revenue) and project cash flows in a constrained environment. All the projects of L&T IDPL have been funded on a non-recourse basis, though this results in higher borrowing costs at the project SPVs. At the beginning of the capex cycle in 2003, there were expectations that the infrastructure boom in the country will lead to the creation multiple LT-like companies. The belief was that some of the mid-sized construction companies would take the leap into the next league. However, looking back at the Golden Decade of Indian Infrastructure, we find very few winners and many losers. LT has emerged much stronger and its competitive positioning in the middle of the current economic cycle is vastly superior as compared to the beginning. We believe this provides LT a uniqueopportunity to capitalize on the ongoing investments in infrastructure and industrial capex.
We have upgraded our FY14 earnings estimate for L&T by 5% to factor in improved business momentum in overseas markets (in L&T International FZE) and marginal improvement in E&C EBITDA margin (up 20bp to 12.3% now), given the sharp decline in commodity prices. We expect LT to report standalone revenue CAGR of 13% and PAT CAGR of 10% over FY12-14; consolidated PAT CAGR would be 9%. We estimate consolidated EPS at INR86 (up 10%) for FY13 and INR93 (up 9%) for FY14. We maintain Buy with a revised SOTP-based target price of INR1,670 (up from INR1,417). We have valued LT standalone at 15x FY14E earnings and subsidiaries at INR439/share. Our revised target price indicates 24% upside. L&T currently quotes at a 12% PER premium to Sensex, which is the lowest since FY04 and we believe that this adequately captures the macro headwinds to the investment climate. Between FY95-04, L&T's lowest PER discount to Sensex was 3.6%, and thus downside is limited from current levels, in our opinion, says Motilal Oswal research report.
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