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L&T: The Goliath cometh

Oct 26, 2007

Performance summary
  • Standalone sales grow 47% YoY in 2QFY08, 39% YoY in 1HFY08 - crosses the US$ 2 bn mark during the half year period.
  • Lower sub-contracting, construction material and staff costs (all as percentage of sales) aid the 4.3% expansion in operating margins during the quarter.

  • Net profits grow 73% YoY during 2QFY08, largely aided by expansion in operating margins as other income declines by 79% YoY.

Standalone performance snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Sales 37,361 54,999 47.2% 72,130 100,052 38.7%
Expenditure 34,979 49,136 40.5% 67,307 89,958 33.7%
Operating profit (EBDITA) 2,382 5,863 146.2% 4,822 10,094 109.3%
Operating profit margin (%) 6.4% 10.7% 6.7% 10.1%
Other income 1,117 233 -79.1% 1,592 2,348 47.5%
Interest 106 132 24.8% 264 290 9.8%
Depreciation 336 483 43.6% 645 907 40.6%
Profit before tax 3,057 5,481 79.3% 5,505 11,245 104.3%
Tax 1,045 2,001 91.5% 1,921 3,996 108.0%
Profit after tax/(loss) 2,012 3,480 73.0% 3,584 7,249 102.3%
Net profit margin (%) 5.4% 6.3% 5.0% 7.2%
No. of shares 286.8
Diluted earnings per share (Rs)* 61.7
P/E ratio (x)* 62.8
* 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 two key segments Ė Engineering and Construction (E&C) and Electrical & Electronics (E&E). While the former contributes to around 68% of L&Tís consolidated gross sales, the latter is around 10%. Out of the remaining 22%, a large share comes from the companyís IT services business. At the end of FY07, L&Tís outstanding order book stood at Rs 369 bn, or 2.5 times its E&C revenues in the fiscal. During the period between FY02 and FY07, the company has grown its revenues and profits at compounded annual rate of 19% and 40% respectively.

What has driven performance in 2QFY08?
Revenues - E&C fillip: L&T grew its standalone sales by 47% YoY during 2QFY07. This growth was led by strong performance from the companyís E&C division, which grew sales by 55% YoY during the quarter. L&T is currently executing some large-scale projects like the Delhi airport, captive power plant for naphtha cracker project for IOC, construction of port facilities, embarkment, bridges, jetty and township including railway electrification and water system works at Dhamra Port, Orissa for The Dhamra Port Company Limited and engineering, procurement, installation and commissioning for 2 new offshore platform, a flare platform and interconnecting bridge for block 5 development in Qatar for Maersk Oil Qatar AS.

At the end of September 2007, the order backlog for the E&C segment stood at Rs 420 bn, 44% YoY higher and more than 3 times the segmentís FY07 revenues. During 2QFY08, L&T won some more large contracts in this space, which are likely to help it sustain strong growth momentum over the next 2-3 years. Some of these contracts include:

  • Rs 7.6 bn contract from Bhushan Steel & Strips Ltd.;

  • Rs 5.7 bn contract from SAIL; and

  • Rs 3.7 bn from Abu Dhabi Water & Electricity Authority

Segment-wise performance (Standalone)
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Engineering & Construction
Order inflows 46,560 59,050 26.8% 109,560 141,230 28.9%
Revenue 27,494 42,626 55.0% 53,682 77,545 44.5%
% share 71.1% 74.0% 72.0% 73.8%
EBIDTA margin 8.6% 11.7% 8.5% 10.8%
Electrical & Electronics
Revenue 4,670 6,717 43.8% 8,914 12,128 36.1%
% share 12.1% 11.7% 12.0% 11.5%
EBIDTA margin 17.5% 17.1% 17.7% 16.9%
Machinery & Industrial Products
Revenue 4,355 5,917 35.9% 7,723 10,144 31.4%
% share 11.3% 10.3% 10.4% 9.7%
EBIDTA margin 15.5% 15.8% 16.7% 18.5%
Revenue 2,125 2,329 9.6% 4,235 5,243 23.8%
% share 5.5% 4.0% 5.7% 5.0%
EBIDTA margin 12.8% 10.3% 12.4% 7.7%

As for the companyís electrical and electronics (E&E) business, sales grew 44% YoY during 2QFY08. The Machinery & Industrial Products (MIP) business recorded sales growth of 36% YoY during the quarter as robust demand from industrial, infrastructure and hydrocarbons sectors led growth for the companyís construction and mining equipments.

Operating margins Ė EPC again: L&Tís operating margins expanded by 4.3% YoY during 2QFY08, again due to a strong performance from the EPC segment. From the expenses side, the improvement in operating margins was led by decline in sub-contracting and construction material costs (both as percentage of sales). However, raw material costs increased from 24.1% in 2QFY07 to 28.9% in 2QFY08, thus paring some gains in operating margins. Based on segments, while PBIT margins of the E&C division improved from 8.6% in 2QFY07 to 11.7% during 2QFY08, those for the E&E business contracted from 17.5% to 17.1%.

Lower other income pares bottomline surge: While L&Tís operating profits surged by 146% YoY during 2QFYT08, the benefit was not fully passed on to the net level, as bottomline grew by a lower 73% YoY. This was on the back of a large 79% YoY decline in other income during 2QFY08. The decline in other income was due to a large Rs 900 m forex translation losses during the second quarter. An increase in effective tax rate, from 34% in 2QFY07 to 37% in 2QFY08, also took some steam off the net profits.

What to expect?
At the current price of Rs 3,877, the stock is trading at a multiple of 27.4 times our estimated FY10 consolidated earnings, which we believe makes the stock expensive from a medium term perspective. The strong surge in the stock price over the past 2 months has taken us by surprise, considering that it crossed our 2-year target price in four weeks! We continue to believe that L&Tís leadership position in the construction, projects and manufacturing-led businesses holds good potential for growth in the future. Also, a healthy backlog provides it the right kind of visibility in terms of future performances. However, we are cautious with respect to the stockís valuations.

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