We have highlighted in the past that concerns about the expansion of the execution time cycle appear to be overdone, and that the increase in execution cycle in F2010 was led by the slowdown?s impact on Larsen & Toubro (L&T) customers (especially private customers), not a change in mix to higher-gestation power projects. Our reduction in the non-power change impact to around 19% over FY11-13e, over and above the 5% power impact we continue to build in, drives a 4-7% upgrade in our FY11-12 revenue estimates. That shift, coupled with the upside surprise we expect in margins in FY10e, leads to a 6-7% upgrade in our FY11-12e earnings.
We continue to build in another 24% increase in the execution cycle over FY11-13 on this account, besides the mix impact, setting the stage for further upside risk in revenues. On the margin front, we assume a 100 basis point decline in FY11 followed by a 50 basis point decline in FY12, which might seem harsh if material prices do not rise as strongly as we anticipate. Hence, despite our estimates being 12-13% ahead of the consensus, we believe that risk remains on the upside.
While L&T, in revenue terms, is larger than the next six largest construction companies put together, given the fragmented market (L&T?s marketshare is still only 2.3% in Indian capex), and its high-quality execution, it has consistently gained marketshare over the last two decades. It has also been the vendor of choice for the private sector, making it the best way we see to play the structural growth story in Indian infrastructure. Our revised price target of Rs 2,017 (up 9%) implies a 20% return from current levels.
Our economist has a bullish view on the new capex cycle coming up (led by private corporate capex), which should benefit L&T?s diversified construction company. The fact that customer funding is picking up on both debt and equity should lead to an execution step up after slowing execution in FY10. Concerns over the expansion of the execution time cycle are overdone, and the increase in the execution cycle in FY10 was led by the slowdown?s impact on L&T?s customers, not a change in mix to higher-gestation power projects.
L&T?s ability to grow its order book when the capex cycle is slowing: Initiatives are in relatively uncontested areas. The ability to turn around the loss-making international subsidiaries is good, shoring up the ability to gain market share.
Given the surprise to our FY10 numbers and our bullish view on the new capex cycle coming up, we are upgrading our revenue numbers for FY11-12e by 4-7%. We build in a margin decline of 100 basis points in FY11e followed by another 50 basis points in FY12e. However, given the higher-than-expected margins in FY10, our Ebitda (earnings before interest, taxes, depreciation and amortisation) margins for the two years actually move up from our earlier estimates. Coupled with the revenue upgrade, the margin increase drives upticks of 7% and 6% in our FY11e and FY12e EPS (earnings per share), respectively. While our FY11e Ebitda number is around management guidance (assuming stable margins), our net income is 12-13% ahead of consensus numbers for FY11-12e. We believe that E&C (engineering & construction) is a difficult business to predict even for company managements, and L&T?s past performance against guidance bears out that view. On the revenue front, while investors would expect the order book to enable the company to accurately forecast growth for the next 12 months, we believe that the difficulty in forecasting quarterly order inflows and clients urgency or the lack thereof makes it a far more difficult task, leading to FY09 being the only year in which the company delivered close to its guided revenue growth. Our FY11e revenue growth at 28% implies a significant beat to the upside.
On the margin front, the company management has consistently guided toward holding the margins constant, which has not really worked in the past. We are building in a 100 basis point dip in FY11e on the back of the rising material (mainly steel) costs.