1. Buy rating on Larsen & Toubro: What lies ahead

Buy rating on Larsen & Toubro: What lies ahead

Infrastructure, heavy engineering, power sectors to drive order flow this year

By: | Published: July 13, 2015 12:06 AM

We met with L&T management recently to seek details on its outlook for the year ahead. The company reiterated its guidance of 15% consolidated revenue growth year-on-year in FY16 as well as improvement in consolidated Ebit margins (ex-service business) by 100 basis points, primarily due to “loss avoidance” in the hydrocarbons business.

As per our discussion, orders in FY16 are likely to be driven by infrastructure, power, heavy engineering & defence and hydrocarbon segments while other segments are expected to remain flat y-o-y. We believe that L&T’s earnings cycle has bottomed out in FY15 and FY16 is likely to see growth revival, driven by execution picking up in the long gestation orders won by the company over the past two-three years.

Continued momentum on order wins, rising exposure back to domestic markets, likely emergence of clarity on business restructuring and value unlocking in subsidiaries make L&T an attractive recovery play in the industrial sector. Our target price on the stock is under review, while we maintain a Buy rating.

Key takeaways from management meeting Core infrastructure orders may rise 30% to Rs 660 bn in FY16.

Roads:  L&T sees traction in road orders from the National Highways Authority of India (NHAI) with orders largely being EPC in nature. There is also an expectation of pick-up in ordering by road developers and state governments as well as better order outlook for border roads and bridges. International prospects in roads also seem bright.

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Dedicated Freight Corridor:  As per L&T, remaining orders from the DFC (especially the Western Corridor) could be ordered out by the end of FY16. While 60-65% of the civil and electrical packages on Western Corridor have already been awarded, the signalling package largely still remains to be ordered.

Railways: L&T expects Mumbai Metro Phase-II ordering for seven packages to commence in FY16. Besides, other metro rail opportunities will arise in the subsequent phases of Delhi, Chennai and Bengaluru cities and any new metro projects that could take off in FY16. There is also rising potential in orders from the Middle East for conventional railway in Qatar, Oman and the UAE. New metro projects in Saudi Arabia (Jeddah and Dammam) are also potential targets for the company in FY16.

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Airports: Not much traction is seen in the segment except for two-three small cities potentially awarding new airport projects.

Urban infrastructure:  The segment is likely to witness pick-up in orders  from the hospital segment as well as from Smart World & Communications segment (includes CCTV surveillance in cities–for which L&T has already bagged an order in Mumbai earlier) and long distance telecom infrastructure (L&T bagged a R25-bn project from BSNL for laying optical fibre cable network for defence). Overall orders from urban infrastructure, however, are likely to remain flat due to overall weakness in the realty segment, in our view.

Water:  L&T sees rising prospects in the water segment as compared to orders bagged worth $1.5 bn in FY15 (vs. $170m four years ago). The company is focusing on lift irrigation projects, which involves major civil works as well as river inter-linking. Opportunities are seen rising in the eastern states and in Andhra Pradesh. Power orders likely to rise by 8% in FY16 to Rs 390 bn.

Power: The management sees 11GW of coal-fired power plant orders potentially coming up in FY16, in addition to four nuclear reactor orders of 700MW each from NPCIL in India. L&T is also looking at possibilities of bidding for hydro projects in Nepal and Bhutan and gas fired projects in Bangladesh. Opportunities also seen in solar where L&T in already the largest EPC player in India.

T&D: Orders are expected to be equally split between India and the Middle East. Hydrocarbon orders likely to rise 33% to Rs 120bn on FY15’s low base.

Hydrocarbon: L&T sees opportunity in the clean fuel projects as mandated by the Centre whereby the refineries will have to upgrade to BS IV fuel production capabilities by FY18. It sees some potential in the midstream with five gas pipeline orders, including a major GAIL package. It also sees opportunities in two fertiliser plant orders as well as from LNG regasification terminal.

Pipeline: L&T expects ordering in offshore upstream to revive this year from ONGC but does not see any refining orders in the pipeline. Overall, opportunity pipeline in the segment is likely to remain more ME (Middle East) focused, however, L&T expects win rate in India to be better thus leading to an equal mix of final orders in hydrocarbon from India and ME.

Metals and material handling orders expected to remain flat at R60 bn for FY16. The outlook for metals and material handling sector remains muted and L&T expects flattish order flow from the segment in FY16 except for some pick-up in coal handling plant orders. Heavy engineering and defence orders expected to rise 20% to R180 bn.

Civil & defence:  L&T sees orders from civil works in defence infrastructure related to bunkers, secret installation air-strips, among others, as well as orders for naval vessels. It is also competing for orders of artillery guns; however, the orders are  expected to be of long gestation duration of as much as six years.

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