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L&T: Engineering story

Oct 1, 2003

Industrial production has shown encouraging increase from 2.6% in FY02 to 5.8% in FY03 and is expected to grow above 6% in the current fiscal. The capital goods industry witnessed a reversal from the negative trend in past two years to 10.5% growth in FY03 and outlook for FY04 looks positive, as we have had good monsoons through out the country. GDP is likely to grow at 6.5% in FY04. L&T, which is going to be a pure engineering company post 2004, is likely to benefit from such a scenario. The company has divided its engineering and construction business in three segments namely construction, heavy engineering and E&C (which involves a mix of engineering and construction). 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. In heavy engineering, the company is into supply of industrial equipments, power plant equipments (including boilers etc.), refinery equipments, defence and nuclear equipments etc. Its E&C division is into installing fertilizer projects and chemical plants etc. The company’s other business i.e. electrical and electronics, consists of manufacturing standard electrical products like transformers and switchgears (for retail segment also).

Lets have a look at the company’s engineering business over last three years.

The company’s engineering and construction business has faired well in last three years. The contribution of this business to total revenues has gone up from 59% in FY01 to 62% in FY03. The revenues from this segment have grown at CAGR of 15% over last three years. The export earnings have grown at a faster CAGR of 68% over last three years. The orderbook size has grown from Rs 92 bn in FY01 to 137 bn in FY03, which stands at 2.2x FY03 segment revenues.

L&T’s electrical and electronics grew at a slower rate as compared to its engineering business. The topline contribution from this segment has remained stagnant at 8% over the last few years. The revenues grew at CAGR of 8%, but exports grew at faster CAGR of 29% in the last three years. The orderbook size for the segment has gone up from Rs 7 bn in FY01 to around Rs 9 bn in FY03, which is more than 1x FY03 revenues from this segment.

Construction is expected to provide large business opportunities in the near and long term as government is laying focus on improving infrastructure facilities. Company expects to increase orderbook size with the coming up of hydro power and irrigation projects. The Electricity Act 2003 will encourage power companies to add lot of capacities. Since L&T is both in construction of power plants and supplying equipments for power generation, it is expected to benefit going forward. As said above, the industrial production is expected to grow by more than 6%. It will help the company to increase its revenues from industrial equipment division. With the huge investments coming up in refineries and oil & gas sector, the company expects to increase revenues from the heavy engineering segment.

(Rs m) FY03 ABB BHEL L&T*
Net Sales 11,758 78,147 73,036
EBIDTA 1,176 7,346 5,916
EBIDTA margin 10.0% 9.4% 8.1%
Market cap/ Sales** 1.7 1.2 0.6
* L&T's cement business revenues excluded
** For L&T, Total current market cap less (value offered by Grasim for cement business)

On the export front, the company has fared well as evident from the figures above. It is focusing on brand building and is also joining hands with other players for bidding of bigger contracts in the international arena. At the current price of 321 the stock trade at P/E multiple of 18.4x FY03 earnings (including cement). Overall, the valuation might look stretched, but once cement business goes away from its books, the engineering business will be at market capitalisation to sales ratio of 0.6x, which is still lower as compared to its engineering peers like ABB and BHEL.

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