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L&T: Attractive valuations?

Feb 22, 2001

There are unconfirmed reports that the cement business of Larsen & Toubro (L&T) has been valued at Rs 67 bn. The net of debt valuation has been put at Rs 40 bn. This puts the per share value of the cement business at Rs 160 per share i.e. 57% of its current value. Thatís Rs 160 for that part of the companyís business, which has been a cash guzzler in recent years. Against this how does the company cash rich EPC (engineering, procurement and construction) business fare?

In recent years, the EPC business has been hit by a slowdown in infrastructure spending. On top of this, competition from international EPC companies is putting pressure on L&Tís margins, which by international standard are on the higher side. Indeed, the management has stated that over the years, these margins would tend to decline, although they would continue to remain higher than the norm. Therefore, slower growth and a pressure on margins have dented the attractiveness of its EPC business. That's the negative side. On the brighter side, L&T is probably the best placed to capitalize on the impending construction boom in the country. Indeed, the company has also made successful forays in various international markets.

How does the EPC business fare in terms of valuations? In FY01E the company will likely earn roughly 60% of its revenues from the EPC and the electrical business group operations. To value this business, we assume a market cap to sales ration of 1. This is based on the fact that BHEL has a Market Cap to sales ratio of 0.83. This would put the market value of these businesses at Rs 43 bn i.e. Rs 170 per share.

The aggregate value would therefore work out to Rs 330 per share, a 15% premium over the existing market price. Therefore, the prevailing price does offer some value to investors. However, it is important to highlight an important point here. L&Tís management has in the past made confusing statements on the restructuring process. If by any chance the cement business were not to be divested, the valuations could suffer significantly. Probably the market is already factoring in that risk.


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