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Larsen & Toubro: An engineering behemoth - Views on News from Equitymaster
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  • May 22, 2012

    Larsen & Toubro: An engineering behemoth

    Infrastructure is a pillar to any economy's growth. It helps build a nation. Therefore, companies engaged in infrastructure creation are effectively wealth builders of the nation. In the Indian context, Larsen & Toubro (L&T) suits this statement to the tee. The company is virtually a pillar to India's infrastructure ambitions. And this is reflected in the company's order book size. L&T's current order book stands at Rs 1.4 trillion.

    The company has been serving the nation since the last seven decades in areas of infrastructure, heavy engineering equipments, and power plant equipments. The company provides transportation infrastructure (roads, railways, metros, ports & airports), water infrastructure and urban building infrastructure (hospitality, educational and healthcare facilities). In the engineering space, L&T manufactures heavy industrial equipments, defence equipments and also provides entire range of services in turnkey power plant construction. Further, it also has stake in hydrocarbons, information technology and financial services business. Thus, L&T is a multi-pronged entity. It also has exposure in the international markets.

    As at the end of FY12, the broad classification of the company's order backlog was as follows: roughly 43% of the orders were from the infrastructure space, 28% from power, and 10% from hydrocarbons while rest from other segments.

    The future of Indian infrastructure & engineering industry

    India's infrastructure is slowly but gradually gathering pace. As a result, plenty of opportunities are on galore. The transportation infrastructure in India is under-developed. And government is taking various steps to increase the same through private sector participation. Private Public Partnership (PPP) is one such step in that regards. Considering the deficit position of the government most projects are likely to be awarded in PPP mode. This throws up huge opportunities for companies in the infrastructure space. Be it roads, ports or airports. The asset ownership (Build, Operate and Transfer) business which offers rich yields will be the key driver for growth in transportation infrastructure.

    Considering that India is an agrarian economy even water infrastructure projects offer huge growth potential. Also, the fact that urbanization is increasing at a rapid pace the activity in the urban building infrastructure segment is also likely to remain buoyant.

    Now, let's have a look at the prospects on the engineering side. It is a known fact that India is a power deficit country. Thus, companies engaged in the manufacture of power generation equipments have huge market potential. Larsen & Toubro (L&T) has a wide power portfolio comprising of boiler, turbine & generators. It also offers entire range of balance of plant offerings. Thus, L&T is uniquely placed to exploit the opportunities available in the market. Presence in the power transmission & distribution side is also an added benefit. That's because the back end power infrastructure in India is still in nascent stages. Apart from this, defence and hydrocarbons space (upstream and downstream) also offer lucrative opportunities.


    High cost of capital and policy paralysis is the main challenge being faced by the industry. Considering high inflation, Reserve Bank Of India (RBI) has adopted a hawkish monetary stance. Although there were rate cuts recently, the current interest environment is still not conducive for corporates. Due to higher cost of capital capex cycles are getting delayed. Even profitability of the Indian companies is getting impacted. Thus, in order to create conducive investment environment, the interest rate cycle should turn favorable.

    Apart from cost of capital, policy indecisiveness is another challenge for the industry. The project award cycle is getting delayed due to environmental and land acquisition issues. Red tape has been another hindrance in execution cycle.

    Both these factors (high interest rates and policy indecisiveness) have impacted the order pipeline of the sector. And this has put the top-line growth under threat. Volatility in commodity prices has also impacted the margin profile of the companies who have higher percentage of fixed orders in their basket. However, it should be noted that the current issues faced by the industry are not structural in nature to have a long term sustainable impact. Once inflation cools down, interest rates will cool down and the capex cycle will gather momentum. Also, the current bureaucratic issues are likely to get ironed out over medium to long term.

    Should L&T Ltd be a part of your stock portfolio?

    L&T Ltd is virtually a proxy to ride on India's infrastructure story. Considering that the company has a wide diversified portfolio it remains immune to a slowdown in one particular sector. Also, international presence, and exposure to finance and IT makes the company's business model resilient. Thus, as an investor you need to recognize that despite being in a cyclical industry, L&T is one of the gems that would not come cheap. It means everything boils down to the price you are willing to pay. Bought with a reasonable margin of safety in valuations, the stock could add immense value to your long term portfolio.

      Jinesh Joshi (Research Analyst) holds a masters degree in Finance and has over 8 years of experience in tracking equities. He has a keen affinity for number-crunching and is often sought after for his valuable insights on financial modeling and valuations. He has a keen eye for spotting emerging growth opportunities across sectors and market caps. Jinesh contributes to our Megatrend investing service The India Letter.



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