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L&T: Fully geared up to serve India
Jul 2, 2009

Engineering behemoth L&T managed to hold its stead quite well in the financial storm that FY09 was. With the optimism surrounding the new government, reforms and its supposed thrust on infrastructure, we met up with the companyís management yesterday to gauge how the companyís ebullient hopes are actually panning out on the ground. Here are the excerpts from the meeting. Current business environment: L&Tís business continues to heavily revolve around investments from the public and private sector. To that extent, the present level of activity from the private sector is still cautious, especially on the front of capital expenditure for expansion. That said, the management has indicated that capital expenditure for productivity expansion is seen as going strong in the short to medium term.

As far as the public sector is concerned, a lot depends on whether the current government indeed executes reforms at the kind of pace it has promised to. Overall, order inflows have not yet begun coming in on a very strong note.

Focus areas for the engineering business going forward: There are a few large segments within L&Tís engineering businesses that form the core of its operations.

  • The first one of these is its infrastructure business which mainly includes roads (where it undertakes only large sized and high value projects), railways (rolling stock, metros etc.), water (consisting of water evacuation, storage, treatment, distribution etc.), airports and factory buildings.

  • The second is its power business, where the emphasis is on generation equipment where L&T would like to get into in a big way. The company has always been a big player in the transmission and distribution (T&D) space and that would continue to be its bread and butter business within the power segment. However, in terms of looking at additional growth areas, the company is making aggressive forays in the generation space too.

    As expressed by the management, this could become a big vertical for the company going forward. The company would seek to focus on nuclear power equipment as well as super critical equipment for power generation. It has already signed MoUs with Westinghouse Electric Company (US), Atomic Energy (Canada), Atomstroyexport (Russia), GE Hitachi Nuclear Energy (US) during FY09 for forays into nuclear power equipment. The nuclear business intends to undertake complete EPC (engineering, procurement and construction) work under its scope.

  • The third focus area for L&T is its hydrocarbons business. This includes all the three major verticals in the industry comprising of upstream (exploration & production), mid stream and downstream (refining & petrochemicals).

  • Another business that holds a big potential for the company going forward is defense. The management has indicated that government manufacturing capacities for a lot of defense equipment are currently fully booked. This makes it likely that they may open up the sector to private players going forward and in that case the potential magnitude of the business would be huge.

Long term vision: As per the current status quo, the companyís business can be broken up as 80% projects and 20% manufacturing. But its long term strategy is to see this ratio change to 60% projects and 40% manufacturing & services (of which its information technology business and financial services business are expected to be big contributors going forward).

The company currently has about 50 to 60 business units each of which are grouped under 12 operating companies. Each of these operating companies function as individual companies within themselves and are held responsible for all their decisions, including having their own risk management strategies firmly in place. This is what makes it easier for the company to manage the magnitude and diversity of operations at the corporate level.

Electricals and Electronics segment: This segment of the company was hit badly during FY09, where it saw its EBIT margins fall by from 14.9% to 10.4%. The reasons for this were a big slowdown in off-take, an over capacity in the industry, input costs that saw a big spike during the year, and customers (mainly SMEs) who were badly hit due to the liquidity crunch during the year. The fortunes of this segment continue to be tied to the overall business environment in the economy.

Margins: There are some factors that contribute towards L&Tís margins in the EPC business being higher than other players that donít have the advantage of integrated operations. In many a projects, L&T enjoys design margins, manufacturing margins and construction margins (which are typically higher). The fact that L&T is capable of offering all these things together puts it at an advantage when compared to players that can offer only one or two of these functions on a standalone basis in a project.

The management has expressed that the companyís current level of margins are already quite healthy and to that extent increasing them further would be quite unlikely going forward.

On competition: Competition has increased sharply for L&T in many of its businesses in the past few years. From here on, the competitive intensity is only going to rise further. But one advantage that the company is currently enjoying is that since the time the credit crisis has broken out, many of the small and medium sized competitors in the sector who were very aggressively pursuing growth with overly stretched balance sheets are now seeing themselves in a weak position as far as their balance sheets are concerned.

Since L&T faces no such problem, in the time that it takes these competitors to repair their balance sheets by raising more funds, the company will be look at taking this time as further strengthening its business presence in various areas.

On Satyam: L&Tís share in Satyam post Tech Mahindraís open offer stands at 8% (down from 12% earlier). Its average buying price for this stake stands at Rs 81 per share. Despite this, the company has written down the value of its stake from Rs 81 per share to Rs 58 per share (the price at which the open offer was conducted). Thus the company has booked a provision of Rs 1.86 bn towards this in Q4 of FY09.

What to expect? At the current price of Rs 1,539, the stock is trading at a multiple of 20.6 times our estimated FY11 earnings, which we believe makes the stock over-valued. Even though the companyís business remains as secure and sound as ever, we remain wary about its over-optimistic valuations on the bourses.

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