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LARSEN & TOUBRO

INDUSTRY CMP Recommend Add on dips to

Sequential Targets

Time Horizon

DATE 4th June 2018

Construction & Engg. Rs 1372

Buy at CMP and add on

declines Rs 1235-1240 Rs 1511 and

Rs 1614 3-4

Quarters

Government thrust on Infrastructure Dominant market position in domestic E&C segment

Value unlocking from sale of non-core business Order inflows picking up

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HDFC Scrip Code CMILTDEQNR

BSE Code 500510

NSE Code LT

Bloomberg LT IN

CMP 18-May-18 1372.4

Equity Capital (Rs cr) 280.3

Face Value (Rs) 2

Eq- Share O/S (Cr) 140.2

Market Cap (Rs cr) 1,92,324

Book Value (Rs) 397.2

Avg.52 Wk Volume 24,34,000

52 Week High 1469.6

52 Week Low 1107.6

Shareholding Pattern % (Mar-2018)

Promoters 0.0

Institutions 56.9

Non Institutions 43.1

Total 100.0

FUNDAMENTAL ANALYST

Atul Karwa atul.karwa@hdfcsec.com

Company Profile: Incorporated in 1938 by Mr H H Larsen and Mr S K Toubro, Larsen & Toubro (L&T) was incorporated in 1946, and was reconstituted as a public limited company in 1950. Headquartered in Mumbai, it has grown to be one of the largest and most respected companies in India's private sector. L&T is one of Asia's largest vertically-integrated E&C conglomerates, with a strong market position across segments such as infrastructure, power, hydrocarbons, heavy engineering, electrical and automation, information technology, technology services, metallurgical and material handling, and machinery and industrial products. L&T undertakes its infrastructure developmental projects (roads, metro rail and ports) largely through its infrastructure subsidiary, L&T IDPL, power generation projects through L&T PDL, and also has a presence in the realty segment with L&T Realty and L&T Seawoods Ltd. Investment rationale: • Dominant market position in domestic E&C segment with diversified revenue profile • Government thrust on Infrastructure • Order inflows picking up • Strong financial flexibility and comfortable capital structure • Value unlocking from sale of non-core business Concerns: • Funding of projects and slowdown in the reform process • High working capital intensity of operations • Execution challenges • Slowdown in the international order book View and valuation: L&T is the market leader for any large infrastructure project in India, and is a proxy for infrastructure development. Revival of domestic capex and higher crude prices would benefit the company in terms of higher order inflows in the domestic market, as well as from international (especially Middle East) markets. The company has guided for 10-12% growth in order inflows, 12-15% growth in revenue and a 25bps margin improvement in FY19. L&T has signed an undertaking with Schneider Electric for the sale of its Electrical & Automation (E&A) business for a consideration of Rs 14,000cr, subject to regulatory clearance which would aid in the freeing up of capital for investing in the high-growth services business. It has focussed on improving its working capital management and return ratios, early signs of which are visible. L&T offers size, visibility, consistency, return to core, and attractive financial parameters. Hence, it deserves to be a part of an investor’s core portfolio, though it is subject to market-related volatility in stock prices. We feel investors could buy the stock at the CMP and add on declines to the Rs 1235-1240 band (18x FY20E EPS and 15.2x FY20E EV/EBITDA) for sequential targets of Rs 1,511 (22x FY20E EPS and 17.4x FY20E EV/EBITDA) and Rs 1,614 (23.5x FY20E EPS and 18.2x FY20E EV/EBITDA) in 3 to 4 quarters. At CMP of Rs 1,372, it is trading at 20x FY20E EPS and 16.3x FY20E EV/EBITDA.

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Consolidated Financial Summary

YE March (Rs cr) Q4FY18 Q4FY17 YoY (%) Q3FY18 QoQ (%) FY17 FY18E FY19E FY20E

Net Sales 40678 36619 11.1 28747 41.5 109312 119683 134271 149593

EBIT 5390 4382 23.0 3144 71.5 11075 13571 15710 17802

APAT 3167 3025 4.7 1490 112.6 6041 7370 8495 9625

Diluted EPS (Rs) 22.6 32.4 10.6 43.2 52.6 60.6 68.7

P/E (x) 31.8 26.1 22.6 20.0

EV / EBITDA (x) 24.1 20.8 18.1 16.3

RoNW (%) 12.8 13.9 14.6 15.1

Key Highlights

L&T has an established track record of ~seven decades, and a strong brand image, with a strong group level order book of Rs 2.6lakh cr as on Mar-18.

Major push from the Government on

the roads, railways, and urban infrastructure segments and revival in private sector capex to help in improving their order book positions.

Order inflows have picked up from

Q3FY18 driven by domestic orders. Overall order inflows grew 6.9% in FY18 over FY17 and order book increased 0.7% to 2.6lakh cr.

Selling off and divesting non-

strategic businesses has given L&T the cash cushion to look into strategic acquisitions in IT and defence technologies

(Source: Company, HDFC sec)

Company profile: Set up in 1938 by Mr H H Larsen and Mr S K Toubro, L&T was incorporated in 1946, and was reconstituted as a public limited company in 1950. Headquartered in Mumbai, it has grown to be one of the largest and most respected companies in India's private sector. L&T is one of Asia's largest vertically-integrated E&C conglomerates, with a strong market position across segments such as infrastructure, power, hydrocarbons, heavy engineering, electrical and automation, information technology, technology services, metallurgical and material handling, and machinery and industrial products. L&T undertakes its infrastructure developmental projects (roads, metro rail, and ports) largely through its infrastructure subsidiary, L&T IDPL, power generation projects through L&T PDL, and also has a presence in the realty segment with L&T Realty and L&T Seawoods Ltd. L&T has several verticals such as Technology, Engineering, Construction, Projects, Manufacturing and Financial Services, with global operations. It addresses critical requirements in key sectors like infrastructure, construction, defence, hydrocarbon, heavy engineering, power, shipbuilding, aerospace, electrical & automation, mining and metallurgy. L&T’s integrated capabilities span the spectrum of ‘Design to deliver’ solutions. Over seven decades of a strong, customer-centric approach, and a sharp focus on superior quality have enabled it to maintain a leading position in its main verticals. The company has manufacturing facilities and offices in several countries, and a global supply chain. It delivers landmark projects and products, offering clients in 30 countries tools to achieve long-term progress and economic growth. L&T has planned a 5-year strategic plan - ‘Lakshya’ - to focus on doubling sales to Rs 2lakh cr by FY21E, improving margins (ex-services) from 10% in FY16 to 11.2% by FY21E, along with value unlocking either by listing the asset or divesting non-core assets. L&T also plans to improve its RoE from 12% in FY16 to 18% in FY21E, and reducing working capital from 24% in FY16 to 18% by FY21E.

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Segment Composition

(Source: Company, HDFC Sec)

Infrastructure Business Ranked among the world’s top 30 contractors, the Infrastructure vertical contributes significantly to the image and stature of Larsen & Toubro across the globe, and giving L&T the reputation of ‘The builder of the 21st century India’. • Building and factories: The company is a market leader in arena of Engineering, Procurement and Construction (EPC), offering turnkey solutions to airports, hospitals,

stadiums, hotels, institutional spaces, IT parks, office buildings, elite residential buildings, high-rise structures, mass housing complexes, factory structures, cement plants and industrial warehouses.

• Transportation Infrastructure: The company offers its services to Roads, Runways (Airside Infrastructure) & Elevated Corridors (RREC), Railways Construction, and Railways Systems & International Infrastructure. The business leverages its vast experience in Project Management, Engineering Design & Construction Management to achieve operational efficiency.

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• Heavy Civil Infrastructure: The Heavy Civil Infrastructure business vertical of L&T Construction undertakes design, engineering and construction of projects in several

segments that are crucial to the economy, like Metros, Nuclear, Hydel, Ports, Special Bridges, Tunnels and Defence. The business has a strong presence in India, the Middle East, Bhutan and Bangladesh.

• Power Transmission and Distribution: L&T’s Power T&D offers integrated solutions and end-to-end EPC services in the field of power transmission and distribution, and solar energy. Besides being a dominant player in the Indian market, the company enjoys a significant share and a strong reputation in the Middle East, Africa and ASEAN markets. The business is well integrated, and has its own tower manufacturing facilities with a capacity of over 1, 25,000 mtpa, strategically located at Puducherry, Pithampur and Kancheepuram.

• Water & Effluent Treatment: Sensing the huge potential in this arena owing to the rise in population, economic growth, climate change, pollution and other challenges, L&T Construction’s Water & Effluent Treatment business segment has swiftly enhanced its process knowhow and detailed engineering capabilities across all streams of the Water and Wastewater business in India, Sri Lanka, Middle East and Africa.

• Smart World & Communication: L&T’s Smart World & Communication Business Unit (SW&C) is well positioned to be a key Master System Integrator (MSI) for Smart City projects. The Business Unit in L&T Construction leads all business initiatives in this realm, and collaborates with L&T Infotech, L&T Electrical & Automation IC and L&T Technology Services to provide end-to-end solutions to customers.

Infrastructure is the company’s largest vertical in terms of order book, revenue and absolute earnings. It had an outstanding order book of over ~Rs 2lakh cr, comprising of 74% of the total orders as on Mar-18. Order inflows amounted to ~Rs 87,300cr in FY18, ~57% of total order inflows. In terms of its contribution to consolidated revenue, its share stood at ~49% in FY18, with an EBIT margin of 8.8%. Power Under the Power vertical, L&T executes coal and gas-based power projects on a lump sum turnkey (LSTK) basis. At its state-of-the-art facilities in Hazira in Gujarat, L&T and its Joint Venture companies manufacture ultra-supercritical/supercritical boilers, turbines and generators, pulverisers, axial fans, air-preheaters and electrostatic precipitators. At the end of FY18, the Power vertical had outstanding orders of ~Rs 9,500cr. Order inflows in FY18 amounted to Rs 2,400cr. The vertical accounted for 5.1% of consolidated revenues in FY18, and registered an EBIT margin of 2.6%. Heavy Engineering L&T’s Heavy Engineering business custom-designs, fabricates and integrates engineered-to-order critical equipment and piping solutions for core sector process plants, power plants and nuclear industries. Its strengths include in-house design & engineering, state-of-the-art fabrication facilities, R&D centres, experienced project teams and a healthy work culture. The business has been a leader in activities like the introduction of new processes, products and materials into the manufacturing sector. All the equipment is manufactured keeping in mind stringent schedules, and conforms to international standards of safety and quality. The business has a track record of executing large size and complex projects. The Heavy Engineering business vertical is structured into two Strategic Business Groups (SBGs): • Process Plant Equipment and Nuclear is involved in the manufacture of large complex equipment such as hydro-processing reactors and high pressure heat exchangers for

process plants, and equipment for the nuclear power sector. • The Defence and Aerospace vertical, having evolved from technology and product development to serial production of equipment and systems to platforms, has resulted

in the emergence of L&T as India’s largest private sector company in the Indian defence sector. L&T is now engaged in design-to-delivery of solutions across its chosen defence segments.

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The Heavy Engineering Business has three manufacturing and fabrication facilities located at Surat, Mumbai and Vadodara. It had an outstanding order book of ~Rs 14,200cr at the end of FY18, comprising 5% of the total order book. Order inflows in FY18 amounted to ~Rs 5,800cr, as compared to ~Rs 7,200cr in FY17. The Heavy Engineering segment accounted for 3.4% of revenue in FY18, with an EBIT margin of 12.5%. Electrical & Automation The Electrical & Automation (E&A) business of L&T offers a wide range of products and solutions for electricity distribution and control in industries, utilities, infrastructure, buildings and agriculture sectors. Its basket of offerings includes Low and Medium Voltage Switchgear components, Electrical Systems, Marine Switchgear systems, Industrial & Building Automation Solutions, Surveillance Systems, Energy Meters and Protection Relays. Currently, E&A has manufacturing facilities at Navi Mumbai (Mahape & Rabale), Ahmednagar, Vadodara, Coimbatore and Mysuru in India, as well as in Saudi Arabia, Jebel Ali (UAE), Kuwait, Malaysia, Indonesia, and the UK. The E&A business accounted for ~Rs 5,700cr of order inflows in FY18, with outstanding orders worth ~Rs 3,200cr. It posted revenue of Rs 5,508cr in FY18, with a share of 4.5% and an EBIT margin of 12.1%. The company has recently signed an undertaking with Schneider Electric for the sale of its E&A business for a consideration of Rs 14,000cr, subject to regulatory clearance. This would aid the freeing up of capital for investing in the high-growth service business. Hydrocarbon The company’s Hydrocarbon business provides integrated ‘design to build’ turnkey solutions for the global Oil & Gas industry, including Oil & Gas extraction and processing, petroleum refining, chemicals & petrochemicals, the fertiliser sector, and cross-country pipelines and terminals for offshore and onshore hydrocarbon projects in India, the Middle East, Asia-Pacific, Africa, the Americas and Europe. The business caters to clients across the hydrocarbon value chain through the following business verticals: • Hydrocarbon Offshore: Lumpsum turnkey EPCIC solutions to the Global Offshore Oil & Gas industry. • Hydrocarbon Onshore: EPC solutions for a wide range of hydrocarbon projects, covering upstream oil & gas processing, refining, petrochemicals, fertilisers (ammonia &

urea complexes), cryogenic storage tanks & regasification terminals including LNG, and cross-country pipelines • Hydrocarbon Construction Services: Turnkey construction services for refineries, petrochemicals, chemical plants, fertilizers, gas gathering stations, crude oil & gas

terminals and underground cavern storage systems for LPG and the cross-country oil & gas pipelines. • Hydrocarbon Modular Fabrication Services: Comprehensive modular Engineering, Procurement and Fabrication (EPF) solutions for projects primarily in the offshore and

onshore Oil & Gas segments • Hydrocarbon Engineering Services: Comprehensive solutions covering the entire spectrum of engineering across the Oil & Gas value chain, covering services from Concept

to Commissioning, Troubleshooting, EPCM, PMC, Engineering & Procurement, Field Engineering, Asset Integrity Management and Operations & Maintenance. The Hydrocarbon business accounted for 10% of the order book, with ~Rs 26,600cr of outstanding orders. Order inflows stood at ~Rs 15,700cr in FY18. It contributed to 9.6% of consolidated revenues in FY18, with an EBIT margin of 6.6%.

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IT & Technology Services The IT & Technology services business is housed under L&T Infotech (L&TI) and L&T Technology Services (L&TTS), both of which are listed separately. In 2016, NASSCOM ranked the company as the sixth-largest Indian IT services company in terms of export revenue. Its clients comprise some of the largest and well-known corporations and Government agencies across the globe, including 52 of the Fortune 500 companies. L&TI offers an extensive range of IT services to its clients in diverse industries such as Banking and Financial Services, Insurance, Energy and Process, Consumer Packaged Goods, Retail and Pharmaceuticals, Hi-Tech and Media and Entertainment, Hi-tech and Automotive, and Aerospace. L&TTS offers design and development throughout the product development chain – providing solutions in mechanical, manufacturing and process engineering, embedded systems and engineering analytics. L&TTS delivers differentiated solutions to build Smart Products, Smart Manufacturing, and enables Smart Services. The IT and Technology Services segment earned revenue of Rs 11,357cr in FY18 (growth of 14.9% YoY), which was 9.3% of the consolidated revenue. It had the highest EBIT margins across all the segments at 18.9% in FY18. Financial Services business The Financial Services business segment comprises of retail and corporate finance, housing finance, infrastructure finance, and the investment and wealth management business, executed by the subsidiaries of L&T Finance Holdings Limited. The Financial Services business also included general insurance, which was housed in a wholly-owned subsidiary, L&T General Insurance Company Limited (L&T GICL). The group divested its stake in L&T GICL during FY17. The Financial Services business contributed to 8.2% of consolidated revenue in FY18 at Rs 10,064cr, with an EBIT margin of 14.3% in FY18 as against 9.2% in FY17. Revenue Break-up (FY18)

(Source: Company, HDFC Sec)

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Investment rationale

Dominant market position in domestic E&C segment with diversified revenue profile L&T has an established track record of ~seven decades, and a strong brand image. It is a dominant player in the domestic E&C segment, and is supported by its ability to cater to several sectors. The business mix spans a spectrum of projects, ranging from complex turnkey engineering, procurement, and construction (EPC) projects, to relatively simple construction activities. In-house design, engineering, and, importantly, fabrication capabilities for critical equipment and systems gives it a notable competitive advantage. These strong competencies across segments and sectors, along with a sound track record of completing projects as per specifications, have resulted in the company having a robust brand image in India and overseas, as indicated by a strong group level order book of Rs 2.6lakh cr as on Mar-18. The company has diversified geographically, with international orders comprising 24% of the total order book. L&T will continue to maintain its dominant position in the E&C market in India by judiciously bidding for projects across segments such as infrastructure (power, roads), urban infrastructure, defence manufacturing, and nuclear. Also, revenue is expected to continue being diversified geographically.

Government thrust on Infrastructure A major push from the Government on the roads, railways, and urban infrastructure segments has helped construction companies improve their order book positions. While the pace of execution has picked up, private sector capex is yet to begin in a significant way (though nascent signs are visible in the metals space). The revival of private sector participation will be key to faster infrastructure development. Railways will be one of the biggest drivers of infrastructure capex over the medium term. Under Bharatmala Pariyojana, which was approved by the Cabinet in Oct-17, 66,100km of National Highways will be constructed in two phases of 24,800 km and 30,600 km each, with a total capital outlay of Rs 6.92lakh cr. Contracts for ~17,000km of roads were also awarded in FY18, as compared to 15,848 km in FY17. The Road Ministry is targeting to add another 25,000 km in new stretches in FY19. The Indian Railways carried out railway track renewal of 4,405 km in FY18 — the highest ever, exceeding the target of 4,389 km and the revised target of 4,400 km for the year. The Railway Business of L&T was awarded the largest-ever composite package in the history of the Indian Railways by DFCCIL (Dedicated Freight Corridor Corporation of India Limited) for track laying, electrification and associated S&T works from Dadri - Rewari for 322 TKms (CTP 14) and electrification of 881 TKms from Mughal Sarai to New Bhaupur Section, Uttar Pradesh for Package CP 204. L&T Construction’s Water & Effluent Treatment business segment has quickly enhanced its process knowhow and detailed engineering capabilities across all streams of the Water and Wastewater business in India, Sri Lanka, Middle East and Africa. The per capita water availability in the country is rapidly decreasing owing to an increase in population and its consumption. The average annual per capita availability of water in India stood at 5,177 cubic meters in 1915, which decreased to 1500 cubic meters as per the 2011 census. It was estimated that by 2015, the per capita availability would dip further to 1100 cubic meters. There are mega Government initiatives to drive water infrastructure in India that include AMRUT (Atal Mission for Rejuvenation and Urban Transformation), Namami Gange, Pradhan Mantri Krishi Sinchayee Yojana and Delhi Mumbai Industrial Corridor Development. With a successful track record, complemented by domain knowledge across business verticals, L&T’s Smart World & Communication Business Unit (SW&C) is well positioned to be a key Master System Integrator (MSI) for Smart City projects. Under the Central Government’s Smart City Mission for developing 109 smart cities across India, 60 cities have already been shortlisted, several of which are in advanced stages of RFPs, and have received Central Govt. funding. L&T bagged the Smart City project in Jan-17 by being identified as the Implementation Partner to convert Pune into a Smart City. After having set up the country's largest surveillance project in Mumbai, involving over 5,000 cameras across 1,500 locations and being in the process of developing Nagpur into India's first large-scale integrated Smart City, this Pune order reaffirms the company’s capabilities in the area of creating a smart world.

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Order inflows picking up Order inflows of L&T were impacted in H1FY18 owing to the subdued investment environment. The order inflow growth declined in both the domestic and international markets in H1. However, order inflows have picked up from Q3FY18 driven by domestic orders, while international orders continued to remain subdued primarily on account of lesser orders from the Middle East owing to declining oil prices. In the domestic market, the public sector still continues to drive capex. Private sector capex, including real estate and building construction, is yet to pick up meaningfully. International order inflows in FY18 have declined by 13.5% YoY to Rs 35,900cr. On the other hand, domestic orders more than compensated for the decline, increasing by 15.3% YoY to Rs 1.2lakh cr. The share of the international order book declined from 26.7% last year to 23.8% in FY18. Overall order inflows grew 6.9% in FY18 over FY17. The recent pick up in oil prices could help in the escalation of investment momentum in the Middle East, which accounts for a major chunk of the international order book. L&T has ~ Rs 2lakh cr of prospective orders in the Infrastructure segment, around Rs 1lakh cr prospective orders in power (generation and T&D together), and ~ Rs 30,000-40,000 cr in the Hydrocarbon segment. Order Inflow Break-up

(Source: Company, HDFC Sec) The overall order book increased by 0.7% YoY to Rs 2.6lakh cr (with de-booking of Rs 16,000cr slow/non-moving orders in FY18, and adjusted taxes post GST) with outstanding domestic orders increasing by 4.7% YoY as of Mar-18, while the international order book declined by 10.5%. The share of the domestic order book grew to 76.2%, as compared to 73.3% at the end of FY17 and 71.8% in FY16. The order book was mainly driven by the Heavy Engineering and Electrical & Automation verticals, which witnessed growth of 8.7% and 20.8% respectively over FY17. The Power sector order book depleted 27.5%, as it is facing challenging times. This decline reflects the depleting domestic order book, as there is severe competition in this segment. The management has guided for 10-12% growth in order inflows, 12-15% growth in revenues on a like-to-like basis, 25 bps margin improvement, excluding the Services business in FY19.

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Order Book Break-up

(Source: Company, HDFC Sec) Strong financial flexibility and comfortable capital structure Strong financial flexibility is driven by the company's demonstrated ability to raise funds at competitive rates, and cash and cash equivalent of ~Rs 17,500cr as on Mar-18. Healthy cash accrual of ~Rs 4,500-6,000cr over the past few years, and periodic divestments have significantly improved the net worth and augmented liquidity. While L&T's net worth has improved significantly over the years on account of the strong cash accruals, its impact on the capital structure has been partly offset by additional investments in subsidiaries, and the greater working capital requirements. Historically, the L&T Group has displayed a conservative financial policy, as is evident in the gearing of less than 2x as on Mar-18. Indigenisation of Defence procurement Keen to be in the forefront of the country’s defence programme, L&T is readying itself to partake in the defence sector opportunity, expected to be worth US$ 150bn over the coming decade. The simplified Defence Procurement Policy came into effect on 1-Apr-16 with preference for indigenously designed and developed products. L&T has been designing and developing complex weapon systems for the Defence Research Development Organisation (DRDO) and the Indian Navy for the last three decades, and is well positioned to capitalise on the Government’s plan to increasingly indigenise defence production. L&T has released over 100 weapon and engineering systems in partnership with DRDO, and independently with in-house capability. Defence procurement is expected to gain traction, and programmes worth approximately Rs 2lakh cr for the Indian industry are expected to get converted into orders over the next two years. L&T has nine dedicated work centres for defence, six of which are new facilities created over the past decade after the opening up of the defence sector. Recently L&T entered into a MoU with Bharat Electronics to cater to the needs of both domestic and export markets for defence products and systems. Through this agreement, both the companies intend to leverage their well-developed supply chain, vast experience and expertise to synergise and enhance exports in the defence sector.

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Value unlocking from sale of non-core business L&T reviews its portfolio and looks for opportunities to divest from non-core businesses to unlock value. In FY17, the company booked gains on the part sale of its shareholding in L&T Infotech and L&T Technology Services, as well as loss on divestment of stake in the General Insurance business. L&T sold its EWAC Alloys arm in Oct-17 to UK-based ESAB Holdings for US$ 80mn. In Aug-17 it sold a cutting tool unit to an arm of Berkshire Hathway, for US$ 27mn. The company has recently signed an undertaking with Schneider Electric for the sale of its E&A business for a consideration of ~Rs 14,000cr, subject to regulatory clearance. This would free capital for investing in the high-growth service business. Selling off and divesting non-strategic businesses has given L&T the cash cushion to look into strategic acquisitions in IT and defence technologies.

Q4FY18 result review L&T reported 11.1% YoY growth in revenue, driven by strong growth in Hydrocarbon, IT & Technology and Financial Services segments. Revenue from Hydrocarbon grew 38% YoY, while IT & Technology and Financial Services reported a growth of 23.7% and 23.4% respectively. EBITDA grew by 21.7% YoY, while EBITDA margins expanded 130bps, led by cost optimisation and operational efficiencies. L&T has recognised a Rs 220cr provision for disputed receivables in Nabha Power and Rs 300cr for other receivables in Q4FY18. Losses from JVs and associates amounted to Rs 117cr, led by an Rs 140cr loss from IDPL with the commissioning of a new road project. Adj. PAT grew by 4.7% YoY, with the normalisation of the tax rate from 9.8% in Q4FY17 to 29.8% in Q4FY18. RoE for FY18 improved 110 bps to stand at 13.9%.

Finalisation of some large infrastructure orders like Mumbai Trans Harbour and other delayed domestic projects supported 7% growth in order intake for FY18. Management expects the order intake momentum to continue driven by infrastructure, heavy civil and hydrocarbon to continue in FY19. The company is L1 in a couple of tenders relating to Purvanchal expressway and is confident of finalisation of Mumbai-Nagpur expressway, Namami Ganga and other big-ticket infrastructure projects in FY19. The company has guided for 10-12% growth in order inflows, 12-15% growth in revenues and 25bps margin improvement.

Rs cr Q4FY18 Q4FY17 YoY (%) Q3FY18 QoQ (%) Operating Income 40678 36619 11.1 28747 41.5 Material consumed 4803 5884 -18.4 4522 6.2 Employee expenses 4128 3501 17.9 3838 7.6 Other expenses 7283 7027 3.6 5782 25.9 Total expenses 35288 32236 9.5 25603 37.8 EBITDA 5390 4382 23.0 3144 71.5 Depreciation 492 723 -31.9 454 8.3 Other Income 433 351 23.2 213 103.3 Interest 418 296 41.4 362 15.3 PBT 4913 3434 43.1 2526 94.5 Tax expenses 1795 864 107.8 796 125.6 PAT 3455 3097 11.6 1789 93.1 Share of Asso/Minority Interest -287 -630 -54.4 -188 52.9 Adj. PAT 3167 3025 4.7 1490 112.6 EPS 22.6 21.6 4.6 10.6 112.5

EBITDA (%) 13.3% 12.0% 128 bps 10.9% 231 bps PAT (%) 7.8% 8.3% -47 bps 5.2% 260 bps

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Concerns Funding of projects and slowdown in the reform process: High levels of NPAs and strained balance sheets of banks pose constraints to the funding of new investments. Structural reforms for debottlenecking economic growth, bringing fiscal prudence in state budgets and faster implementation of various development programmes of the Government are very important for the speedy revival of the investment climate. Geopolitical risks: Unexpected political changes in some developed countries, BREXIT, trade barriers and increasing conflict in the Middle East are some of the risks that the company faces. Fall in oil price: It has resulted in Budget constraints in the countries in the Middle East, leading to a decline/delay in investment, with some projects being put on hold. Competition: It has been observed that competition from foreign and domestic players has considerably increased in the past few years. Execution challenges: The company faces execution challenges like geological setbacks, availability of the work front, land acquisition & right of way (ROW), pending approvals and clearances from Government agencies, working in difficult/harsh weather conditions and terrain, manpower issues etc. High working capital intensity of operations: Project delays and adverse contractual payment terms lead to increased working capital requirements. However L&T’s working capital management has been the most commendable amongst its peers. Lower returns from significant capital employed in some projects: RoCE of the company remained constrained due to existing investments in developmental projects such as Nabha, as well as owing to investments in projects which are yet to achieve the Commercial Operation Date (CoD), such as the Hyderabad Metro and Uttaranchal Hydro Power. These investments are giving marginal or NIL returns, depressing the overall RoCE. Cost overruns in BOT projects: Highly-geared build, operate, transfer projects are fraught with construction risks, which may lead to a cost overrun in the pre-commercial operations phase, and temporary cash gap funding in the initial years post COD, which constrains significant improvements in the RoCE. Delay in capex cycle recovery: Currently, growth is led by Government capex. Private sector capex has still not revived post demonetisation and GST. Further delays in the private sector’s capex revival could lower growth for the company. Slowdown in the international order book: The international order book accounts for 25%, with a significant chunk from the Middle East. A slowdown in capex due to a sharp drop in global oil prices can severely impact L&T’s order intake and revenue accruals from the Middle East. Commodity price rise: With close to 50% of fixed-price contracts in the order book and increasing commodity prices, margins are expected to be under pressure. Other risks: L&T faces other risks such as onerous contract terms by clients, tight schedules, counter-party risks, localisation requirements, forex exposure, etc. These are mitigated by specific actions like operational excellence initiatives, alliances, cost optimisation, improved customer intimacy, compliance with stringent HSE standards, proactive forex hedging, strong contract & claims management, and identification of key personnel and talent in the pre-bid stage.

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View and valuation L&T is the market leader for any large infrastructure project in India, and is a proxy for infrastructure development. Revival of domestic capex and higher crude prices would benefit the company in terms of higher order inflows in the domestic market, as well as from international (especially Middle East) markets. The company has guided for 10-12% growth in order inflows, 12-15% growth in revenue and a 25bps margin improvement in FY19. L&T has signed an undertaking with Schneider Electric for the sale of its Electrical & Automation (E&A) business for a consideration of Rs 14,000cr, subject to regulatory clearance which would aid in the freeing up of capital for investing in the high-growth services business. It has focussed on improving its working capital management and return ratios, early signs of which are visible. L&T offers size, visibility, consistency, return to core, and attractive financial parameters. Hence, it deserves to be a part of an investor’s core portfolio, though it is subject to market-related volatility in stock prices. We feel investors could buy the stock at the CMP and add on declines to the Rs 1235-1240 band (18x FY20E EPS and 15.2x FY20E EV/EBITDA) for sequential targets of Rs 1,511 (22x FY20E EPS and 17.4x FY20E EV/EBITDA) and Rs 1,614 (23.5x FY20E EPS and 18.2x FY20E EV/EBITDA) in 3 to 4 quarters. At CMP of Rs 1,372, it is trading at 20x FY20E EPS and 16.3x FY20E EV/EBITDA.

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Financial Statements - Consolidated

Rs cr FY16 FY17 FY18E FY19E FY20E Income from operations 101122 109312 119683 134271 149593 Cost of materials consumed 14549 16016 15505 17724 20045 Employee Cost 13331 13853 15292 17187 18998 Other expenses 21596 25080 26618 29540 32761 Total expenses 90521 98237 106112 118561 131792 EBITDA 10601 11075 13571 15710 17802 Depreciation 1787 2370 1929 2190 2459 Other Income 9719 10106 13055 15064 16989 EBIT 904 1401 1412 1544 1646 Finance Cost 1793 1340 1539 1807 1995 Profit Before Tax 8020 8887 11639 13256 14993 Tax Expenses 2437 2149 3199 3712 4198 Profit After Tax 5583 6739 8440 9545 10795 Adj. PAT 4233 6041 7370 8495 9625 EPS 30.3 43.2 52.6 60.6 68.7

Rs cr FY16 FY17 FY18E FY19E FY20E Profit Before Tax 7925 8766 11639 13256 14993 Depreciation 1787 2370 1929 2190 2459 Others 773 63 -2442 -903 -6539 Change in working capital -10510 -1763 -4646 -5664 -3678 Tax expenses -3215 -3202 -3199 -3712 -4198 CF from Operating activities -3240 6235 3281 5168 3036 Net Capex -4322 -2979 -2020 -2500 -2800 Other investing activities 202 -6600 2650 -3500 -500 CF from Investing activities -4627 -9740 630 -6000 -3300 Proceeds from Eq Cap 70 53 1460 0 0 Borrowings / (Repayments) 10472 3369 13548 4000 5000 Dividends paid -1512 -1702 -2691 -3195 -3700 Interest paid -2462 -1565 -2169 -1807 -1995 CF from Financing activities 7253 3527 -6312 -1002 -695 Net Cash Flow -613 22 -2401 -1834 -959

Income Statement

Cash Flow Statement

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Rs cr FY16 FY17 FY18E FY19E FY20E EQUITY AND LIABILITIES Share Capital 186 187 280 280 280 Reserves and Surplus 43994 50030 55377 60676 66602 Shareholders' Funds 44180 50217 55657 60956 66882 Minority Interest 2893 3564 5625 6295 7045 Long Term borrowings 73239 77419 88192 90692 93692 Deferred Tax Liabilities (Net) -736 -1125 -1494 -1494 -1494 Other Long Term Liabilities 323 363 422 423 457 Long Term Provisions 425 527 524 631 703 Non-current Liabilities 73250 77184 87644 90252 93358 Short Term Borrowings 14897 16557 19332 20832 22832 Trade Payables 27004 29774 37795 38055 40783 Other Current Liabilities 28744 30129 34385 36243 41186 Short Term Provisions 2387 2899 2484 2993 3335 Current. Liabilities 73032 79359 93996 98123 108136 TOTAL 193354 210324 242921 255627 275421 ASSETS Net Block 14176 13074 14234 14813 15418 Capital work-in-progress 10974 13471 13443 13175 12911 Non current Investments 7971 9383 10193 10193 10193 Long-Term Loans and Advances 52217 52011 63610 70112 78113 Other Non-current Assets 564 775 5202 1032 1179 Non-current Assets 60752 62170 79005 81337 89485 Current Investments 7494 13799 9464 12964 13464 Inventories 4854 4140 4848 5002 5653 Trade Receivables 26025 27970 34654 36605 40379 Cash and Bank Balances 5390 5572 8033 6199 5240 Short-Term Loans and Advances 26776 32468 27008 31894 36341 Other Current Assets 36913 37659 52232 53639 56530 Current Assets 107453 121609 136238 146303 157607 TOTAL 193354 210324 242921 255627 275421

Balance Sheet

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Particulars FY16 FY17 FY18E FY19E FY20E EPS (Rs) 30.3 43.2 52.6 60.6 68.7 Cash EPS (Rs) 43.1 60.1 66.4 76.2 86.2 BVPS (Rs) 316.2 358.8 397.2 435.0 477.3

P/E (x) 45.3 31.8 26.1 22.6 20.0 P/BV (x) 4.3 3.8 3.5 3.2 2.9 Mcap/Sales (x) 1.9 1.8 1.6 1.4 1.3 EV/EBITDA 25.2 24.1 20.8 18.1 16.3

EBITDAM (%) 10.5 10.1 11.3 11.7 11.9 EBITM (%) 9.6 9.2 10.9 11.2 11.4 PATM (%) 4.2 5.5 6.2 6.3 6.4

ROCE (%) 7.3 7.3 8.5 9.0 9.5 RONW (%) 9.9 12.8 13.9 14.6 15.1

Current Ratio (x) 1.5 1.5 1.4 1.5 1.5 Quick Ratio (x) 1.4 1.5 1.4 1.4 1.4 Debt-Equity (x) 2.0 1.9 1.9 1.8 1.7

Debtor days 102 92 95 98 95 Inventory days 21 15 14 14 13 Creditor days 94 96 103 105 98

Financial Ratios

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Fundamental Research Analyst: Atul Karwa (atul.karwa@hdfcsec.com) HDFC securities Limited, I Think Techno Campus, Building - B, "Alpha", Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai 400 042 Phone: (022) 3075 3400 Fax: (022) 2496 5066 Website: www.hdfcsec.com Email:hdfcsecretailresearch@hdfcsec.com. Compliance Officer: Binkle R. Oza Email: complianceofficer@hdfcsec.com Phone: (022) 3045 3600

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