Larsen & Toubro Limited (L&T) is a technology, engineering, construction and manufacturing company. It is one of the largest and most respected companies in India's private sector.

L&T with its unique business model mark its presence in almost all sectors which provides it the immense growth opportunities in terms of revenues and expansion. Currently with the robust order book worth Rs. 115400cr (2.6x of revenue FY10) L&T clearly portrays its positive earnings in future. The heavy order book has 95% of its order from the domestic market which signifies the demand scenario within the country and the arising consumption demand. L&T has plans to venture into banking business through its subsidiary L&T Finance (one of the third largest NBFC in India) so that it gets access to cheaper funds and increase its presence in the field of infrastructure financing. This will reduce the cost of interest of L&T leading to higher profit margins. L&T has plans to restructure its 37000 cr business into 9 independent entities. This restructuring would help the company to increase its focus and activities into the respective sector and diversify its business easily. The huge expenditure on research & development has always let L&T to offer more contemporary and competitive and helps in fetching orders in stiff international competition.

VALUATION

At the current price of Rs. 1679, the stock is trading at 19.84 times of our estimated FY11E earnings, while it is available at just 17.74x of FY12E. We thus recommend a `BUY' with a target price of Rs. 2080

COMPANY PROFILE

Larsen & Toubro was a partnership firm founded by Mr. Henning Holk Larsen with Mr. Soren Kristian Toubro later converted to a public limited company in the year of 1950. The company's primary focused in the areas of Engineering & Construction, Electrical & Electronics, Machinery & Industrial Products and in IT & Technological Services.

In 1981-82 company acquired 2 bulk shipping carriers from Japan and in the year 1983-84 started one cement plant with capacity of 1 MTPA at Maharashtra which is now transferred to Ultra Tech Cement Company making its mark in shipping and cement sectors. The company is well positioned to exploit the opportunities that will come from hydrocarbon, infrastructure, power, minerals & metals and other industrial sectors.

L & T received a host of awards, medals and trophies for its continuous efforts which includes Environmental Excellence Gold award from Green tech Foundation in 2003-04 and 2004-05. Engineering Export Promotion Council (EEPC) offered a trophy for high exports. During the financial year of 2004-05 Business world's survey on India's Most Respected Companies, ranked L & T the First in Infrastructure Sector. The Ministry of Power conferred the first prize in National Energy Conservation for the year 2005.

BUSINESS MODEL

Turnkey Projects: The Engineering & Construction (E&C) Division forms the biggest segment in Larsen & Toubro Limited's business portfolio. This division is capable of carrying out turnkey projects in core industry sectors on EPC basis. The Engineering and Construction Division has integrated its strengths in process technology, basic and detailed Engineering, modular fabrication, procurement, project management, construction and commissioning.

Construction: The Engineering, Construction and Contracts (ECC) Division of L&T is the largest construction organization in the country and ECC finds its unique position (35th as per ENA, USA - August 2009) among the world's top contractors. The Construction Division's cutting edge capabilities cover every discipline of construction: civil, mechanical, electrical and instrumentation engineering and the services are extended to large industrial and infrastructure projects from concept to commissioning.

Engineered Products & Systems: L&T's Heavy Engineering Division has established a reputation in global markets for quality products. The Division manufactures and supplies custom designed and engineered critical equipment and systems to the needs of core-sector industries and the defence sector.

Electrical & Electronic Products & Systems: Electrical & Electronics Division is one of the core businesses of L&T - India's largest engineering and construction conglomerate. The division has operations at different locations in India (two in Mumbai and one each in Ahmednagar, Mysore, Faridabad and Coimbatore) and one unit for manufacturing operations in China. Another manufacturing facility is soon going to come up in Saudi Arabia.

IT & Engineering Services: Carrying the brand and the legacy of Larsen and Toubro group of companies, L&T Integrated Engineering Services has been rated the No. 1 engineering services provider in the 2008 Black Book of Outsourcing. The end-to-end services involve product design, analysis, prototyping & testing, embedded system design, production engineering, plant engineering, buildings & factories design, asset information management & sourcing support using cutting- edge CAD / CAM / CAE technology in the various domains.

Machinery & Industrial Products: L&T offers a range of industrial machinery and products that are designed and developed in-house or are manufactured in partnership with world leaders. Marketing and customer support for these products are provided by L&T through a wide network of offices and service centers.

Shipbuilding: L&T's Shipbuilding facility has been created at Hazira Works to cater to the needs of growing global demand for construction of specialized oceangoing vessels. The shipyard is geared up to take up construction of niche vessels such as specialized Heavy lift Cargo Vessels, CNG carriers, Chemical tankers, defense & para military vessels and other role specific vessels.

Railway Projects: In Larsen & Toubro, India's rail sector can find the partner that it needs. L&T has the requisite capability and the commitment. The Company's track record indicates its involvement in projects of national importance. L&T is and has been a virtual private sector partner to the nation in providing technology, engineering and construction capability in the areas of infrastructure development, hydrocarbon projects, space research, defence, steel, etc.

Financial Services: L&T Finance is one of the leading NBFCs in the country and offers a wide spectrum of financial products and services for trade, industry and agriculture.

SUBSIDIARIES

L&T InfoTech Incorporated in 1997, it is a wholly owned subsidiary of L&T. It is a global IT services and solutions provider. It provides the winning edge to the clients by leveraging its Business-to-IT Connect and deeply committed people.

L&T Finance: it is a 100% subsidiary of L&T engaged in the business of short to medium term financing viz. construction equipment, commercial vehicles, tractors, and farm equipment, channel finance, micro finance etc.

L&T Infrastructure Finance: It is wholly owned subsidiary of L&T which provides financial products and services for clients engaged in infrastructure sector.

INVESTMENT ARGUMENT

Strong Order Book
The order book of L&T as on 6 Jan 2011 stands at Rs. 115400 crore (2.6x of revenue). The company bagged orders worth Rs 36,000 crore in the first half, up
29% y-o-y. Development assets portfolio of the company currently comprise of 5682 Lane KM spread in 15 project with an aggregate cost of Rs 13200 crore, 3 power project with an aggregate generation capacity of 1559 MW and aggregate cost of Rs 15700 crore. Apart from this the company has 3 port projects with aggregate handling capacity of 45 MTPA involving a project cost of Rs 5300 crore, Hyderabad Metro Rail project for 71.16 KM at a cost of Rs 15000 crore and 14 Urban Infrastructure projects of 24 million at a cost of Rs 7800 crore. All these projects involve an aggregate project cost of Rs 57000 crore at the end of Sep 2010. Out of which the equity commitment is Rs 11400 crore and of which the company has invested Rs 3400 crore at the end of Sep 2010. Currently the export orders accounts for just around 5% of the total order book. The robust order book of the company clearly reflects the growth prospects in its future revenue earnings.

Capacity Expansion
L&T regularly increases its capacities to meet the increasing volumes of business. The company's supercritical power plant manufacturing ventures are being commissioned which will improve the efficiency for power projects. Construction of L&T's shipbuilding facility cum container port at Kattupalli, near Chennai is underway. The port at Dhamra in Orissa will soon be ready for commissioning and is expected to provide a boost to L&T' developmental (Asset Ownership) business. The company also intends to have hydel power capacity of more than 2000MW in the next two years.

Business Integration
To strengthen the competitive advantage, enhance margins, acquire greater control over business segments, and bid for large and complex jobs, L&T constantly seeks to achieve higher level of vertical integration.

Potential Opportunities
The company is likely to witness a significant increase in spends considering depleting water tables across the country. It will help it to expand its business in areas of bulk transmission, water treatment and waste water management.

L&T has opportunity in mass urban transit systems (metro and mono rails), station development, rolling stock manufacturing units for Indian Railways, railway sidings for industrial units, and opportunities in dedicated freight corridor.

Venturing into banking business
L&T has plans to venture into banking business through its subsidiary L&T Finance (one of the third largest NBFC in India) so that it gets access to cheaper funds and increase its presence in the field of infrastructure financing. For the same purpose L&T Finance Holdings has filed for an IPO on September 27,2010 and is expected to raise Rs 15bn.

Strategic Joint Venture
A joint venture of Larsen & Toubro and Mitsubishi Heavy Industries inaugurated the country's first private sector facilities for the manufacture of supercritical boilers and turbine generators at Hazira, Surat. This supercritical technology for coal-fired power plants is globally recognized as one of the most eco-friendly solutions to power generation. The technology ensures higher fuel efficiency leading to higher plant efficiency. Carbon emissions are reduced by as much as 5%. This will prove to be manufacturing the world class products and meet the enhanced requirement of power generation equipments.

Restructuring its business
L&T has plans to restructure its 37000 cr business into 9 independent entities with each operating with different chief executive, human resource heads and independent books of accounts. Such a large-scale division of an established conglomerate would be the first of its kind. Power, hydrocarbon, machinery & product, switchgear, heavy engineering, infrastructure, building & factories, metals & minerals and electrical businesses make up the nine independent companies. This restructuring would help the company to increase its focus and activities into the respective sector and diversify its business easily.

Research & Development
L&T incur huge expenses on R&D to increase its product range with technology up gradations and cost reductions which helps in making its equipment offering more contemporary & competitive and helps in fetching orders in stiff international competition.

Robust Industrial Growth
India's annual industrial production growth slipped to lower-than-expected 2.7% in Nov'2010 (the growth was expected at 6.6%) on account of poor manufacturing output that constitutes 80% of the IIP basket. The steepest decline was witnessed by consumer non durables that posted a negative growth of 6%. The Industrial Output growth for Oct'2010 has been revised upwards to 11.3% from 10.8%. But on Y-O-Y basis IIP growth has increased by 28.37% to 9.5% in April-November 2010 from 7.4% in April - November 2009 and the growth in capital goods is by 13.63% Y-o-Y to 12.5% in April-November 2010 from 11% in April - November 2009. It is estimated that their lies a growing demand for industrial production due to the future expansion plans by government and the capacity addition in power sector to meet the domestic demand of the country. And since L&T has a major of 94% orders from domestic market, it clearly portrays the inflow of orders for the company.

Increasing Capital Expenditure by Government
On a yearly basis, India Inc is estimated to incur capital expenditure of about Rs 6 lakh crore in 2010-11 reasonably higher compared to the last two fiscal years when it stagnated around Rs 4.6 lakh crore levels. The capex cycle has already begun can be gauged from the sharp rise in India's capital goods index the average monthly growth in the index at 46 per cent has been impressive. The beneficiaries of this increase in investments will be the engineering and capital goods companies. Since L&T has a well-diversified revenue mix and strong execution and technical capabilities, it is considered to play on the upturn in the capex cycle.

Strong Execution Capabilities
The company has the proven track record for timely execution of projects. Due to their good track record they are preferable vendor. Due to their technology advancement it always clear the benchmark set for technical competency during the bidding process.

With robust order book position, earning visibility of the company is good for next 2-3 years. However low operating margins as compared to its peers is a concern for the company.

During the quarter ended Dec, 2010, the net sales of the company reported an increment of 40.52% on y-o-y basis to Rs 11413 cr as against Rs 8122cr during the corresponding quarter last year. On a sequential basis the company's performance was impressive, and the net sales saw an expansion of 22.32% from Rs 9330cr to Rs. 11413cr. BTG orders have started contributing to revenues.

On the operating front, the EBIDTA registered a growth of 22.57% to Rs 1520cr from Rs 1240cr as against corresponding period last year, while on sequential basis EBIDTA registered a growth of 9.55% from Rs 1387cr. The company has been able to improve its operating margins, largely on account of higher capacity utilization.

The net profit of the company saw an increment of 10.77% YoY to Rs 840cr as against Rs 758cr during the corresponding quarter, while on Q-o-Q basis the net profit inclined by 9.88% from Rs 764cr. The set back in the performance is due to increased interest cost due to higher borrowing level and rise in interest rates.

KEY CONCERNS:

Higher input cost:
The company's input cost is higher. It is the main area of concern as it impacts the operating margins of the company.

Lower Exports:
The company gets its major export projects from Middle East and till the ordering in Middle East picks-up the contribution of exports will not improve. Currently the export orders accounts for just around 5% of the total order book.

Forex price speculation:
Since the company have orders from global market any fluctuation in the foreign exchange prices would impact.