Larsen and Toubro: How well is the company doing; will it power its stock? Here is what you should know

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Published: October 16, 2017 3:09:06 AM

Stripping off losses from Hyderabad metro would increase consolidated RoE to 19% and EPS to Rs 85 in FY2020e. CMP is 8% shy of pricing static ordering over FY2017-20e. We retain Add rating, estimates and target price.

Analysis retains all operational estimates for consolidated ex-services business; CMP is close to pricing in a 0% ordering CAGR over FY17-20e.

L&T can report an 18% RoE in FY2020 versus 12.5% in FY2017 based on (i) potential sale of assets, (ii) improving working capital, (iii) support to shipbuilding segment from a near-term defence opportunity, and (iv) modest estimates for its consolidated-ex services business. Stripping off losses from Hyderabad metro would increase consolidated RoE to 19% and EPS to Rs 85 in FY2020e. CMP is 8% shy of pricing static ordering over FY2017-20e. We retain Add rating, estimates and target price.

19% consolidated adjusted RoE by FY2020 is a fair possibility…

Our base case builds a 16.5% consolidated RoE in FY2020 at static working capital assumptions and no sale of assets. A higher 18% RoE print is possible assuming (i) sale of the loss-making roads portfolio and other assets, (ii) improvement in utilisation levels of the loss-making shipbuilding business on a near-term opportunity in defence, and (iii) working capital improvement of 1% of sales every year. If we were to take the liberty of stripping off the losses from Hyderabad Metro (expected to come in black after FY2028 in our estimates), L&T could show an adjusted RoE of 19% in FY2020. Investors may then be willing to pay a higher multiple for the resulting adjusted FY2020 consolidated EPS at Rs 85, considering the 19% RoE profile in spite of building in sustained losses from the forging business.

…in an unchanging macro for domestic

All through our pro-forma analysis, we retain our operational estimates for the key consolidated-ex services business. Key among these is a 10% CAGR for order inflows over FY2017-20E or a 3% CAGR over FY2015-20e. We assume a flat to declining Ebitda margin trajectory for all business segments reporting positive Ebitda. We note the possibility of (i) orders panning out weaker than our estimates if private corporate capex continues to decline in FY2018 and (ii) margin panning out stronger than our estimates as the share of domestic business increases in the mix.

CMP is close to pricing in a 0% ordering CAGR

Given the business volatilities inherent in the EPC business, investors may consider building in a margin of safety while considering investing in L&T. We find it relevant to point out that L&T’s CMP is 8% shy of levels that would discount a 0% ordering CAGR over FY2017-20e at a 1X lower 17X target multiple on discounted FY2020 core E&C EPS. Such a target multiple is more like 15X as the 2X addition is not linked to the state of the domestic private capex cycle.

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