Equity Analysis: Larsen & Toubro LimitedIndustry: Engineering

June 2011

Presented By:

Jitendra Kumar

Industry Overview

• The Engineering sector is the largest in the overall industrial sectors in India. • It is a diverse industry with a number of segments, and can be broadly

categorized into two segments, namely, heavy engineering and light engineering.

• Approximately 15-20 %growth rate in industry expected (LNT growing @ 25%)

• Most of the leading players are engaged in the production of heavy engineering goods and mainly produces high-value products using high-end technology. Requirement of high level of capital investment poses as a major entry barrier.

• Leading players in this industry are L&T, ABB, BHEL, Siemens, Thermax, Crompton Greaves, Voltas

• The light engineering goods segment, on the other hand, uses medium to low-end technology. Entry barrier is low on account of the comparatively lower requirement of capital and technology.

• The demand in the engineering sector to remain to be healthy primarily on account of the Government’s increased thrust on infrastructure development.

• Industry margins growing @ 12-15%• Industry profitability approximately 10-14%

Company Overview

• Larsen & Toubro Limited (L&T) is a technology, engineering, power, construction and manufacturing company.

• It is one of the largest and most respected companies in India's private sector with a strong revenue growth of 25% and order inflow growth of 15-20% in FY2012.

• Leadership position in all its major lines of business. • L&T has an international presence, with a global spread of offices and

factories. Has strong footprint in the Gulf and in China.

Subsidiaries• Larsen & Toubro Komatsu Limited• Larsen & Toubro Finance• Larsen & Toubro Infrastructure Finance• L&T – Integrated Engineering Services (IES)• Larsen & Toubro Valves Business Group

Firm's competitive position:

• Impact on margins:• EBITDA margin stable at 15.2% and strong inflows of Rs 303 bn.• Capital Investment Requirement:• L&T reported a strong balance sheet at the end FY 2011 with a marginal

deterioration in working capita levels & gross debt to equity of 0.33X.• L&T increased its investments in its subsidiaries and associates by 29.6bn

to 106.4 bn at end FY2011 from FY2010-end level of Rs. 77bn primarily led by(1) buy out of PE stake in L&T IDPL and investment in other development projects of Rs. 10.7 bn

• (2) Increase in investment in L&T finance and L&T infrastructure finance by Rs. 6.8 bn. (3) Increase in investment in L&T power development to the tune of about Rs. 4.6 bn.

• Growth Rates:• Management guided for strong revenue (25%) and inflows (15-20%)

growth in FY2012 end. • Our estimates build a marginal order inflow growth of 3% and strong

revenue growth of 24% for FY2012 end.

Key Parameters

Source: Kotak Institutional Equities’ research report

Summary Profit & Loss a/cP & Loss statement for L &

T (standalone), ends, 2011-2016E (Rs mn)            

  2011 2012E 2013E 2014E 2015E 2016E

Net sales and services 4,42,812 5,26,515 6,25,008 7,32,698 8,55,907 10,04,427

Other operating income 4,135 4,754 5,466 6,286 7,229 8,313

Net operating revenues 4,46,947 5,31,269 6,30,474 7,38,984 8,63,136 10,12,741

Direct costs (3,44,567) (4,09,872) (4,86,443) (5,71,886) (6,67,965) (7,83,741)

Gross profit 1,02,381 1,21,398 1,44,031 1,67,098 1,95,171 2,29,000

S,G&A expenses (17,431) (19,126) (22,697) (26,603) (31,073) (36,459)

Salaries and wages (28,657) (36,031) (43,647) (51,159) (59,754) (70,111)

EBITDA 56,293 66,241 77,687 89,336 1,04,344 1,22,430

Interest expense (6,796) (7,471) (7,471) (7,471) (7,471) (7,471)

Depreciation (4,972) (5,815) (6,469) (7,168) (8,018) (9,043)

EBIT 44,524 52,955 63,747 74,697 88,856 1,05,917

Other income 11,771 10,746 10,152 10,152 10,152 10,152

PBT 56,295 63,702 73,899 84,849 99,008 1,16,069

Taxes (18,690) (21,149) (24,535) (28,170) (32,871) (38,535)

Tax rate (%) (33.2) (33.2) (33.2) (33.2) (33.2) (33.2)

Net income 37,605 42,553 49,365 56,679 66,138 77,534

Extraordinaries - - - - - -

Reported net income 37,605 42,553 49,365 56,679 66,138 77,534

Summary Balance Sheet

  2011 2012E 2013E 2014E 2015E 2016E

Liabilities            

Equity share capital 1,210 1,210 1,210 1,210 1,210 1,210

Reserves and surplus 2,14,388 2,47,028 2,86,480 3,32,541 3,88,062 4,54,979

Total Equity 2,15,598 2,48,238 2,87,690 3,33,752 3,89,272 4,56,189

Reval reserves 233 233 233 233 233 233

Secured loans 9,557 9,557 9,557 9,557 9,557 9,557

Unsecured loans 73,451 73,451 73,451 73,451 73,451 73,451

Total Liabilities 2,98,839 3,31,479 3,70,931 4,16,993 4,72,513 5,39,430

             

Assets            

Gross fixed assets 87,931 1,01,931 1,15,931 1,32,341 1,51,507 1,73,996

Accumulated Depreciation

(22,249)

(28,064)

(34,533)

(41,701)

(49,719)

(58,762)

Balance sheet Cont…Net fixed assets 65,682 73,868 81,398 90,639 1,01,788 1,15,234

Capital work-in-progress 5,000 5,000 5,000 5,000 5,000 5,000

Intangible assets 1,427 1,427 1,427 1,427 1,427 1,427

Investments 1,48,042 1,57,529 1,67,114 1,85,079 2,07,929 2,35,546

Deferred tax assets (774) (774) (774) (774) (774) (774)

Deferred revenue items - - - - - -

Cash and Bank balances 7,406 6,969 11,011 11,562 12,140 12,747

Inventory 84,923 1,00,976 1,19,865 1,40,517 1,64,147 1,92,630

Debtors 1,45,582 1,73,101 2,05,482 2,40,887 2,81,394 3,30,223

Advances 72,791 86,550 1,02,741 1,20,443 1,40,697 1,65,111

Other current assets 11 11 11 11 11 11

Creditors 97,055 1,15,401 1,36,988 1,60,591 1,87,596 2,20,148

Advances fromcustomers 1,09,187 1,29,826 1,54,112 1,80,665 2,11,046 2,47,667

Other current liabilities 500 500 500 500 500 500

Provisions 24,510 27,451 30,745 36,042 42,103 49,409

Net working capital (ex-cash) 72,056 87,461 1,05,754 1,24,060 1,45,004 1,70,251

Miscallenous expenditure            

Total Assets 2,98,839 3,31,479 3,70,931 4,16,993 4,72,514 5,39,430

Discounted Cash Flow

Cash Flow Working

  2011 2012E 2013E 2014E 2015E 2016ETerminal

Value

PAT

37,605

42,553

49,3

65

56,6

79 66,138

77,5

34  

Depreciation 22249.2

28,064

34,533

41,701

49,719

58,762  

Change in Fixed Assets

(17,000)

(14,000)

(14,000)

(16,410)

(19,166)

(22,488)  

Change in W.C.

(2,626)

(2,941)

(3,294)

(5,297)

(6,061)

(7,306)  

Interest

6,796

7,471

7,471

7,471

7,471

7,471  

               

Projected Cash Flows

49,035

61,146

74,075

84,144

98,100

1,13,972 24,60,286

Discounted Cash Flow

49,035

53,126

55,9

18

55,1

88 55,903

56,4

29 12,18,118

WACC-Target PriceCost of Equity Using CAPM Model

Rf 8.24% 10 year Benchmark Gsec Yield

Rm 15% Expected Market Return

β 1.1128

R Equity 15.76%

10 Year Benchmark G Sec Yield 8.24%

AAA Corporate Bond Spread 1.23%

Tax Rate 30.00%

Total Debt (2011) 83241.2

Total Equity (2011) 10,56,970 Market Capitalisation as on 24th June

WACC 15.10%

• Terminal Value at the end of FY 2016• Assumption: Free cash flow growth falls to 10% after 2016 and remains constant thereafter

forever• G FCF 10%• R WACC 15.10%• Terminal Value (Rs. Mn) 24,60,286 • Enterprise Value (Rs Mn) 15,43,718 • Value of Equity (Rs. Mn.) 14,60,710 • Estimated Price (Rs) 2,413.60