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L&T: E&C everywhere!
Jan 29, 2007

Performance summary
Indiaís largest engineering company, L&T, has announced decent results for the third quarter and nine-months ended December 2006. For 3QFY07, on a standalone basis, revenues have grown by 12% YoY. Stock-related adjustments and lower sub-contracting charges have buoyed the operating margins, with the same having expanded by 2.8% during the quarter. Consequently, and also due to higher other income and lower interest expenses, L&Tís net profits have jumped 33% YoY during 3QFY07. Performance for 9mFY07 has been similar, with topline and bottomline growing by 12% YoY and 29% YoY respectively.

Standalone performance snapshot
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Sales 36,887 41,184 11.6% 101,178 113,306 12.0%
Expenditure 34,108 36,929 8.3% 96,074 103,939 8.2%
Operating profit (EBDITA) 2,780 4,255 53.1% 5,104 9,367 83.5%
Operating profit margin (%) 7.5% 10.3% 5.0% 8.3%
Other income 608 1,279 110.4% 2,984 2,582 -13.5%
Interest 225 12 -94.6% 470 276 -41.2%
Depreciation 266 357 33.9% 821 1,002 22.1%
Profit before tax 2,896 5,166 78.4% 6,797 10,671 57.0%
Extraordinary income/(expense) 235 - 617 -
Tax 538 1,727 220.9% 1,961 3,648 86.1%
Profit after tax/(loss) 2,593 3,439 32.6% 5,453 7,023 28.8%
Net profit margin (%) 7.0% 8.4% 5.4% 6.2%
No. of shares 134.8 280.6
Diluted earnings per share (Rs)* 41.7
P/E ratio (x)* 38.9
* On a trailing 12-months basis

What is the companyís business?
Larsen & Toubro (L&T) is Indiaís largest engineering company with expertise in wide areas like infrastructure, oil and gas, power and process. The company has broadly segregated its business into three key segments Ė Engineering and Construction (E&C), Electrical & Electronics (E&E) and Machinery & Industrial Products (MIP). While E&C contributed to around 73% of L&Tís standalone 9mFY07 revenues, E&Eís contribution was 12%. During the period between FY03 and FY06, L&T has grown its consolidated revenues and profits at compounded rates of 17% and 34% respectively.

What has driven performance in 3QFY07?
E&C leads the way: In line with its performance in the past few quarters, L&Tís E&C division has yet again led the topline growth for the company. For 3QFY07, this segment recorded a growth of 7% YoY, contributing to 73% of the companyís total standalone revenues. The segment was a beneficiary of increased investments in the infrastructure and hydrocarbon sectors, both in the domestic and international markets. The segmentís order booking was higher by 26% YoY (to Rs 82 bn) during 3QFY07. At the end of December 2006, the divisionís order backlog stood at 341 bn, almost 2.9 times the segmentís full year sales in FY06. Investors should note that more than the large order backlog, a large part of the same (over 40%) is made up of orders related to the hydrocarbon and defense sectors, where, on the basis of the superior technological expertise requirements, margins are relatively superior as compared to the infrastructure segment.

Segment-wise performanceÖ
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Engineering & Construction
Revenue 29,510 31,595 7.1% 79,037 85,278 7.9%
% share 76.3% 73.2% 75.5% 72.5%
PBIT margin 7.1% 10.3% 5.7% 8.7%
Electrical & Electronics
Revenue 3,833 4,825 25.9% 10,882 13,739 26.3%
% share 9.9% 11.2% 10.4% 11.7%
PBIT margin 15.6% 14.7% 14.3% 15.4%
Machinery & Industrial Products
Revenue 3,493 4,066 16.4% 10,221 11,789 15.3%
% share 9.0% 9.4% 9.8% 10.0%
PBIT margin 14.9% 13.6% 12.3% 15.0%
Others
Revenue 1,829 2,677 46.3% 4,606 6,899 49.8%
% share 4.7% 6.2% 4.4% 5.9%
PBIT margin 2.0% 3.1% 5.5% 7.0%
Total*
Revenue 38,665 43,163 11.6% 104,745 117,705 12.4%
PBIT margin 8.4% 10.7% 7.2% 10.0%
* Excluding inter-segment adjustments
* Excluding inter-segment adjustments

As far as the electrical and electronics (E&E) business is concerned, revenues grew by 26% YoY during 3QFY07. Growth in this segment should be seen on the backdrop of a benign investment scenario in the power sector, which has continued to benefit L&T. The Machinery & Industrial Products (MIP) business recorded sales growth of 16% YoY during the quarter.

Lower sub-contracting charges aid margin expansion: L&Tís operating margins expanded by 280 basis points (2.8%) during 3QFY07, which was a result of stock related adjustments and lower sub-contracting charges. However, raw material costs (as percentage of sales) increased from 22.3% in 3QFY06 to 28.8% in 3QFY07, thus paring further expansion in operating margins. Even staff costs increased from 6.4% in 3QFY06 to 7.4% in 3QFY07, largely due to 22% YoY increase in headcount as also the salary hikes affected during the quarter. Based on segments, while PBIT margins of the E&C division improved from 7.1% in 3QFY06 to 10.3% during 3QFY07, those for the E&E business contracted on a YoY basis.

Better margins, higher other income leads bottomline growth: Sharp expansion in operating margins combined with substantially higher other income helped L&T post a 33% YoY growth in bottomline during 3QFY07. Lower interest costs also played their part in propping up the net profits during the quarter. However, the companyís effective tax rate jumped from 19% in 3QFY06 to 33% in 3QFY07, thus paring any further upside on the bottomline front.

What to expect?
At the current price of Rs 1,620, the stock is trading at a multiple of 19.7 times our estimated FY09 consolidated earnings. Considering L&Tís 9mFY07 performance, we shall maintain our FY07 revenue and net profit estimates for the company. We remain buoyant on the company's increasing focus on the hydrocarbons and defence engineering spaces, while maintaining a strong traction in the infrastructure sector. We maintain our postive rating on the stock from a long-term perspective.

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