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L&T: An outlook

Jan 14, 2004

Engineering companies gained substantially on the bourses in the last one year. With the increased GDP growth rate and higher IIP accompanied by the power reforms, the orderbook sizes of most of the engineering majors have been on a rise. In this context, lets take a look at L&T, throw some light on its engineering business and evaluate the export focus of the company. The engineering business of L&T includes heavy engineering division, construction division, EPC division and electrical and electronic division. The dynamics of all these divisions differ from each other. Let's have a close look at these segments.

In construction, the company is into constructing thermal and hydro power plants, roads, highways and bridge construction and installing water supply and affluent treatment plants. The company has been undertaking construction projects in the Middle East for over three decades. L&T has divided the construction business into four zones viz. the East, West, North and South, and each zone covers a few neighboring countries in addition to the domestic market.

In heavy engineering, the company is into supply of industrial equipments, power plant equipments, refinery equipments, defence and nuclear equipments etc. Around 40% of the company's heavy engineering revenues come from exports. Currently the division is servicing more than 45 countries all over the world including advanced countries such as US and Japan. The engineering and construction business has grown at a CAGR of around 10% over last 3 years.

The company's E&C division is into installing fertilizer projects and chemical plants. This division of the company deals with turnkey projects. Over the years, the company has gained expertise in developing off shore platforms and cement plants and is targeting relatively smaller countries like Qatar and Tanzania to set up large value projects. It's other business i.e. electrical and electronics, consists of manufacturing standard electrical products like transformers and switchgears. The company has been introducing contemporary products at a very fast pace and is also trying to reduce the new products introduction cycle. This division has growth at a CAGR of around 88% over last 3 years.

The projected orderbook size of L&T stands at around Rs 130 bn for FY04, which is around 1.8 times the company's FY03 engineering division revenue. Looking the huge orderbook size, we believe that the company's topline will grow at a higher rate of 35% in FY04. At the current price levels the stock trades at the market cap/sales ratio of 0.9x FY04 expected revenues. Where as BHEL trades at market cap to sales ratio of 1.7x expected FY04 revenues.

Going by international standards, the valuation of L&T looks stretched. However, we should keep in mind that India is a growing market. So in the initial stages of growth, the companies have higher growth potential as compared to international giants like GE, which operate in a developed economy. Overall, one has to take a balanced view between the long-term growth potential and the ability of the management to deliver in the future for its shareholders, who have borne the burnt of past diversification moves.

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