Larsen & Toubro - moving from strength to strength; result update Q3FY08; upgrade to Buy

Larsen & Toubro (LT IN, INR 3,770, upgrade to Buy)

The key highlights of Larsen & Toubro’s (LT) Q3FY08 results were 55% Y-o-Y growth in revenues and all round impressive performance from all segments. For the third time in a year, the management has revised revenue guidance upwards and expects 35-40% Y-o-Y growth going forward. Net profit was at INR 4.8 bn, a 40% Y-o-Y growth, translating into EPS of INR 16.5 for the quarter.

Rolling our sum-of-the-parts (SOTP) valuation from FY09E to FY10E and incorporating value arising from new businesses (ship building, railways, power equipment), we arrive at equity value of INR 1,493 bn (INR 5,117/share). We are upgrading our recommendation from ACCUMULATE to BUY as the stock has corrected by 12% from our previous result update and the current P/E of 22x FY10E earnings provides comfort on valuations.

Strong revenue growth; margins in line
Stellar performance from all segments resulted in 55% Y-o-Y growth in LT’s revenues to INR 63.8 bn in Q3FY08. The E&C segment, contributing ~75% to revenues, witnessed the highest growth of 57% Y-o-Y. Order booking for the quarter grew by 40% Y-o-Y to INR 115 bn for the E&C segment, thereby leading to a healthy order backlog of INR 476 bn. Adjusted EBITDA (see clarification 1, page 4) stood at INR 7.4 bn for Q3FY08, up 62% Y-o-Y. As a result, EBITDA margins were at 11.6%. The Y-o-Y EBITDA margins are not strictly comparable, as Q3FY07 numbers have been restated (see clarification 2, page 4). Interest expense more than tripled to INR 438 mn in Q3FY08, mainly on account of interest related to USD 265 mn ECB borrowing and issuance cost of INR 70 mn. LT’s net profit was at INR 4.8 bn, 40% Y-o-Y growth, translating into EPS of INR 16.5 for the quarter.

Outlook and valuations: Its bigger and better; upgrading to ‘BUY’
With management’s increased thrust to grow core businesses and higher visibility provided by its subsidiary portfolio (as BoT projects enter operational phase), we expect consolidated revenue and earnings to grow at a CAGR of 34% and 37% Y-o-Y, respectively, over FY08-10E. Our consolidated EPS for FY09E and FY10E now stand at INR 126 and INR 169, respectively. We are rolling our SOTP valuation methodology from FY09E to FY10E for standalone and subsidiary portfolio and assigning value for foraying into newer businesses. On account of the roll over, our SOTP value for standalone and subsidiary portfolio now stands at INR 4,461/share, up by INR 400/share. We are also adding INR 655/share to our SOTP on account of value arising from entry into new businesses. As a result, our SOTP equity value now stands at INR 1,493 bn (INR 5,117/share). We are upgrading our recommendation from ACCUMULATE to BUY as the stock has corrected by 12% from our previous result update and current valuations (P/E of 22x FY10E earnings) provide comfort.