>Larsen & Toubro (EDELWEISS)

Too early to cheer

INR 57.8 bn worth orders booked; is the tide turning?
From March 30–April 9, 2009, Larsen & Toubro (LT) has announced orders worth INR 57.8 bn, primarily in power and process verticals. For Q4FY09, the company has announced orders worth INR 51.4 bn (order intake in Q4FY09 will, however, be higher as small-ticket orders have not been announced). Even with the spate of orders in the last week of Q4FY09, we believe the initial order accretion guidance (30% growth) for FY09 is unlikely to be met. While the order accretion growth for 9mFY09 has been strong at 30%, inflows in oil & gas (O&G) have been significantly below estimates; for 9mFY09, O&G order intake has been INR 43 bn (down 32% Y-o-Y). While the current order announcements by LT in the power and infrastructure verticals, is certainly a positive, we believe it is too early to conclude that the same will translate in to higher-than expected order inflows in FY10.

Power and infrastructure likely to drive order accretion growth in FY10
In FY10, LT’s order accretion is likely to be driven primarily by power and infrastructure verticals. In power, LT expects equipment orders from the 11 negotiated tenders from NTPC and DVC. In infrastructure, railways, roads, and airports would remain key drivers; railway orders are, however, expected to pick up significantly only post FY11 on the back of the Dedicated Freight Corridor (planned investment of INR 600 bn by 2016). Although order accretion has been weak in the company’s O&G vertical in FY09, management expects orders to start flowing in from Q1FY10.

Execution issues on 6% book; likely to rise in our view
Currently, our main concern is execution of current orders in the process vertical. LT’s order book is at INR 688 bn (37:63 public versus private; private includes 11% from group development projects); 6% of these could get delayed primarily in metals and real estate verticals, according to the management. We believe this percentage could be higher given that the company’s exposure to key problem verticals of metals, real estate, and O&G is at 40% of the current order backlog.

Outlook and valuations: Uncertainty overhang; maintain ‘REDUCE’
We value subsidiaries at INR 123. Hence, the implied P/E for the parent business is 14x and 12.5x for FY10E and FY11E, respectively. In the face of an uncertain macroeconomic environment, which could put the private sector capacity addition under a cloud, we believe upsides to valuations from current levels are likely to be capped over the medium term. We maintain ‘REDUCE’ recommendation on the stock.

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