Friday, June 15, 2012

>Larsen and Toubro - Call to order: Policy, demand hold key; company update; Buy

We analysed key verticals like Power, Metals, Hydrocarbons and Infrastructure to gauge the depth and diversity of L&T’s order intake. Our bottoms up analysis deduce that the order intake in FY13E-FY14E would grow at a CAGR of 11%-12%, led by a recovery across segments. We foresee strong growth in Hydrocarbons, Power T&D & Railways over FY13E-14E, given strong project pipeline & L&Ts clear focus. While policy traction will remain critical on various issues including coal & land availability etc, overall demand sentiment will also play a major role to determine the extent of industrial capex recovery. We maintain Buy with a TP of INR 1528.

Bottoms up imparts visibility for order intake growth
We appraised projects in key verticals like Process, Power, Infrastructure, Hydrocarbons etc to review our FY13E & FY14E fresh intake assumptions. While we could gather confidence regarding overall new order intake growth of 10-11 % over next two years, we believe Hydrocarbons, Power T&D and Railways (DFCC+Metro) will support order inflow growth in the coming years.

Policy traction, demand sentiment hold key to recovery
 As interest rates begin to come down, we remain optimistic about higher spending by the private sector. However, we also believe that policy action by the government in key areas like coal, iron ore, gas and environmental clearances would be critical to lift the sentiment as well as industrial capex hence this is the number one variable for the sector.

Outlook and valuations: Positives loom large; maintain ‘BUY’
We continue to consider L&T as a benchmark indicator of the domestic industrial capex spending. Given the rate reversal and expected policy clarity in issues like coal, mining and large project clearances, we remain positive on the company over the next 12-15 months. Moreover, value unlocking in subsidiaries like IDPL and the sale of switchgear business etc could further support the stock which currently trades at a P/E of 15.8x and 13.9x on FY13E and FY14E earnings respectively on a consol basis. We maintain BUY/SO rating on L&T with a revised target price of INR1528 (earlier INR1457).