>LARSEN & TOUBRO: 2012 AND BEYOND (MACQUARIE RESEARCH)

■ L&T set to look more like a conglomerate
FY12 will be a very significant year for L&T as it will herald in changes, including a new management team after 15 years of stable management, key new business initiatives that are beginning to contribute meaningfully to revenues and the possible unlocking of value in some subsidiaries. We attempt to paint a picture of what L&T would look like in FY12 and after based on our assessment of the core business and about 50 key subsidiaries.

■ FY12 to be critical year of developments for L&T

FY12 will likely be a significant year for L&T for numerous reasons.

⇒ Maturing of key businesses: L&T IDPL could see more than 11 projects reach the commissioning stage, while the power equipment business could see robust revenues as boiler and turbine plants’ utilisation improves.

⇒Value unlocking in some of the businesses: L&T’s IDPL and L&T Finance could tap the market for resources to achieve future growth. Even the Infotech business could see a large transaction and listing, possibly earlier than FY12.

⇒ Mass scale management changes: The entire senior management staff, which has been at the helm of affairs, will retire in late-FY12. The management of the various strategic business units would form the pool for the next level of senior management. This would also crystallise the SBU structure within the company.

■ Core business to benefit from upturn in execution
We remain much more positive than the consensus on the upturn in revenue growth as the execution rate on projects picks up. We expect revenue growth of 28% in FY11, which could drive earnings upgrades in the core business. We are 12% above the consensus on FY11 earnings. Moreover, order inflow growth is likely to remain robust in FY11, even from a high base in FY10, boosted by a continued focus on infrastructure and an uptick in the corporate capex cycle.

■ Capital allocation strategy remains a matter of concern
L&T management views the IT and financial services business as part of the core operations. We suspect the company might attempt to in-organically expand its IT business as scale becomes increasingly critical. We believe the size of investment is an overhang on the stock. Similarly, there is no clarity on the end game in the financial services business, especially given stakes in small regional banks and the requirement of large doses of capital. However, we think the listing of subs in the services business would materially reduce the incremental capital required to be invested in these companies, reducing one of the key overhangs on the stock.

■ Earnings/valuations of subs underestimated, TP of Rs1,952
Based on our analysis of L&T’s subsidiaries, we estimate the EBITDA contribution to consolidated P&L could increase to 28% in FY12 from the current 17% and may expand further thereafter. Our estimate of the subs contribution to earnings is around 50% higher than the consensus for FY11 and FY12. Based on key value-unlocking events that we think are likely to play out over the next 12 months and clarity emerging on the earnings potential of subs, we arrive at a 2012 March fair value of Rs2,013, building a 15% holding-company discount for subsidiaries. Our one-year target price is Rs1,952, upside of 19%, adjusted for time value.

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