Initiate coverage with ‘buy’ rating on L&T with a price target of Rs 2,107.83 per share. Prima facie, the shares look expensive, but given it would be the pre-eminent beneficiary of a rise in domestic capex, we think valuations will sustain in the initial stage of the upcycle. Our price target is 24% above the current level. The Middle Eastern business (about 25% of the Q3 FY15 order book) is the biggest risk factor, as delays in execution could impact both revenue and margins.
Over the past five years, the key driver of order growth has changed from power, to buildings, to core infrastructure. The gap in scale vis-à-vis other contractors is only widening, and L&T’s revenue as a proportion of total capex in India has risen from 1.4% in FY04 to 2% in FY14. With the average ticket size of contracts increasing and smaller contractors constrained by their balance sheets, we believe L&T will continue to gain market share.
We believe L&T’s E&C revenue growth over FY13-15e (9% CAGR) has lagged growth in its adjusted starting order book over the same period (21% CAGR). We expect this dichotomy to correct and forecast E&C revenue growth to accelerate to 21% over FY15-17, as execution of large new infrastructure orders ramps up. Improvement in cyclical conditions should boost execution rates, which are at cyclical lows. The drag from smaller segments will abate as the base effect kicks in over the next few quarters.