Larsen & Toubro – L&T reported weak results with standalone revenue growth of 4.2% versus expectations of 7.5%. EBITDA margins contracted YoY to 10.5% from 11.6% in 3Q FY15 ostensibly on job mix and some orders not crossing the margin recognition threshold.
While L&T, in revenue terms, is larger than India’s next six largest construction companies put together, owing to the fragmented market (L&T’s market share is still only 2.5% in Indian capex) and its high-quality execution, it has consistently gained market share over the last two decades. It is also the vendor of choice for the private sector, making it the best way to play both the impending recovery in capex and the structural growth story in Indian infrastructure. We believe that as the return of capex becomes more visible, the focus of the market will shift within the sector towards the executors (EPC companies) as opposed to the assets owners today, since the former’s earnings growth will be strongly affected by the return vs. the latter’s.
In the last 12 months, given the low visibility on the return of capex, the market has continued to exhibit a
preference for infrastructure developers with stable cash flows within industrials. Even stocks like IRB, where
earnings growth has not been exceptional, have done extremely well, given how much investors in the sector
were focused on stability in the last 12 months
L&T trades at ~15x adj. FY17E standalone EPS and 20x consol. EPS. It also trades at ~3x FY2016E book value even though core RoCE is 16-18% and reported RoE is under pressure due to near-term infrastructure losses.
Sum of the Parts Valuation of L&T
Core Business 1,785
Infotech 105
IDPL 148
Finance 100
Super Critical JV 62
In all L&T’s SOTP comes to Rs 2,200 on FY 2016 earnings while EPS expectation is around Rs 66 [P/E Multiple is a tad on higher side, but stock market likes to discount 2017 earnings]