INDIA DAILY October 5, 2012 India 4-Oct 1-day1-mo 3-mo Sensex 19,058 1.0 10.1 8.7 Nifty 5,788 1.0 10.8 8.6 Contents Global/Regional indices Daily Alerts Dow Jones 13,575 0.6 4.0 5.3 Nasdaq Composite 3,149 0.5 2.6 5.8 Company FTSE 5,828 0.0 3.0 2.4 Larsen & Toubro: So far so good Nikkie 8,861 0.4 2.1 (2.4) Hang Seng 20,969 0.3 9.5 5.9 Sector KOSPI 1,996 0.2 6.5 6.4 Automobiles: 2QFY13 results preview Value traded – India Metals & Mining: 2QFY13E preview - metal stocks stare at weak operational Cash (NSE+BSE) 176 144 124 quarter Derivatives (NSE) 1,090 735 716 Deri. open interest 1,366 1,130 1,161 Strategy Strategy: Sentiments drive alpha in CYTD12 even as value flourishes in September Forex/money market Change, basis points 4-Oct 1-day 1-mo 3-mo Rs/US$ 51.6 14 (427) (372) 10yr govt bond, % 8.4 - (1) (3) Net investment (US$mn) 3-Oct MTD CYTD FIIs 155 199 16,333 MFs (57) (75) (282) Top movers -3mo basis Change, % Best performers 4-Oct 1-day 1-mo 3-mo UNSP IN Equity 1254.7 0.3 23.7 69.5 Z IN Equity 204.9 5.3 19.7 37.7 FTECH IN Equity 1002.8 3.5 21.2 34.2 UTCEM IN Equity 1982.1 (1.4) 18.3 28.4 GRASIM IN Equity 3397.8 0.7 16.1 27.6 Worst performers NACL IN Equity 51.3 0.8 2.7 (17.1) BHARTI IN Equity 269.8 1.7 4.6 (16.8) WLCO IN Equity 100.3 0.1 4.5 (16.3) BOI IN Equity 305.3 0.1 19.7 (13.9) SESA IN Equity 175.1 (0.8) 6.7 (13.5) For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES. REFER TO THE END OF THIS MATERIAL. REDUCE Larsen & Toubro (LT) Industrials OCTOBER 04, 2012 UPDATE Coverage view: Cautious So far so good. While L&T inches closer to Rs200 bn inflows/quarter run-rate in 2Q also, Price (Rs): 1,634 note that 45% of this was from real estate with attendant concentration risks. Several Target price (Rs): 1,515 headwinds remain pertinent to (1) replacing in-house inflows (15% of total) with reluctance BSE-30: 19,058 to commit fresh capital, (2) sweet spot in real estate has helped but PSU/Govt tendering (about 50%) is quite competitive with L&T win rate being quite low (0-35%, 5-7 bidders), (3) valuations at 15.5X one-year forward P/E (adjusted standalone) seem full considering slower earnings growth (10-14% vs 30% CAGR till FY2012). Retain REDUCE (TP: Rs1,515). Company data and valuation summary Larsen & Toubro Stock data Forecasts/Valuations 2012 2013E 2014E 52-week range (Rs) (high,low)1,637-969 EPS (Rs) 76.1 84.6 92.9 Market Cap. (Rs bn) 1,000.7 EPS growth (%) 12.4 11.2 9.8 Shareholding pattern (%) P/E (X) 21.5 19.3 17.6 Promoters 0.0 Sales (Rs bn) 643.1 793.1 940.4 FIIs 17.3 Net profits (Rs bn) 46.3 51.5 56.6 MFs 6.8 EBITDA (Rs bn) 87.4 107.6 128.2 Price performance (%) 1M 3M 12M EV/EBITDA (X) 16.4 14.3 12.5 Absolute 19.6 15.2 22.1 ROE (%) 16.1 15.1 14.1 Rel. to BSE-30 9.5 5.5 1.6 Div. Yield (%) 0.9 0.9 0.9 Strong inflow momentum but too much dependence on urban real estate driven by sweet spot L&T announced orders to the tune of Rs158 bn in 2QFY13 (reported Rs196 bn in 1QFY13) of which about 44% of orders were from urban real estate (40% in residential itself). We understand that L&T enjoys a sweet spot in urban real estate with developers having an opportunity to boost project credentials (and pricing) by using L&T as the construction contractor. However, urban real estate may have its own risks related to clearances, completion timelines and developer finances. Sweet spot does not apply to other areas, particularly in Government/PSU contracts A similar sweet spot does not seem to exist in other areas, particularly in Government contracts. Business originating from this segment is highly competitive—L&T’s strike rate from clients such as NPCIL (36%), NMDC (nil), ONGC (27%), NTPC (nil in bulk tender), etc. has been relatively low. While we do not expect L&T to win 100% of these orders, we note that order wins may not be an easy walk in this segment. Public sector orders (including in-house) formed about 50% of inflows over the past 2-3 years. While balance sheet stress may inhibit some contractors from bidding for development projects, these players would still bid for cash contracts. Several headwinds remain related to inflows mix, slow investment pick-up in power, metals, O&G We also note headwinds related to (1) high proportion of orders from highly competitive (T&D) and plain vanilla (buildings, roads) segments may adversely impact margins, (2) potential difficulty in replacing in-house orders (17% of backlog) in context of incremental reluctance to take up more development jobs; NHAI also shifting gears towards EPC versus BOT, (3) sustained weak investment cycle (power, metals, hydrocarbons, etc.) and (4) lower-than-expected scale-up in international orders. Even with limited capital commitments, consolidated returns may remain range-bound till FY2015E Despite limited incremental capital commitments, we believe that the consolidated returns of L&T may still remain range-bound (RoE at 14-15% and RoCE at 6-7%) till FY2015E. L&T is trading at relatively full 12-month forward valuations of 15.5X P/E (standalone adjusted for Rs420/share value and dividend income from subs), 13.3X EV/EBITDA (consol.) and 2.5X P/B (consol.). Retain REDUCE (TP: Rs1,515) on weak cyclical outlook creating risk for inflows, margins and working capital. Key upside risks relate to potential stake-sale transactions at higher-than-attributed values and higher-than-expected margins. For private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL. Larsen & Toubro Industrials Strong inflows momentum so far though primarily driven by urban real estate L&T announced orders to the tune of Rs158 bn in 2QFY13 (versus reported number of Rs196 bn in 1QFY13 and announcements of Rs156 bn in 1QFY13). Of the Rs158 bn announced in 2QFY13, Rs69 bn is from the industrial & commercial buildings segment, about Rs22 bn from water segment (water supply schemes) and Rs16 bn from T&D sector (file contains the detail list and segmental split of the orders). L&T had guided for 15-20% growth in order inflows—which implies Rs800-850 bn of orders in full-year FY2013E (our estimate of Rs765 bn). L&T has reported 44% of orders out of total of Rs158 bn from urban real estate (with 40% in residential alone). We understand that L&T enjoys sweet spot in urban real estate with developers having an opportunity to boost project credentials (and pricing) by using L&T as construction contractor. However, we believe that urban real estate has its own risks related to clearances, completion timelines and finances of developers. Rough break-up of sector-wise order inflows of L&T Segment 2008 2009 2010 2011 2012 1QFY13 2Q13-Ann. 1Q+2Q Ann. 2013E 2014E Infrastructure 130 (100) 201 (185) 188 (112) 303 (220) 339 (256) 127 (132) 112 239 407 407 Roads and bridges 3 43 — 33 82 68 9 78 100 Ports and airports 55 — — 22 8 5 — 5 25 Railways 3 28 8 70 21 6 11 17 40 Industrial & commercial bldg 33 92 92 72 118 50 69 119 200 Water 6 23 13 23 27 4 22 26 50 Power 59 (35) 129 (80) 230 (217) 255 (200) 148 (111) 41 (20) 16 57 163 196 BOP 5 20 45 46 2 — — — 50 EPC — — 103 93 18 1 — 1 Equipment — 16 24 28 — — — — Electrification/ T&D 30 45 45 32 91 19 16 34 115 Process + Oil & Gas 168 (137) 144 (140) 230 (168) 183 (139) 156 (87) 14 (7) 21 35 144 158 Refineries 38 37 21 12 — — 13 13 Petrochemicals 3 8 30 — 10 — — — Minerals & metals 54 80 43 99 38 7 — 7 Bulk material handling — — — 4 — — — — Platforms 42 — 74 18 31 — 7 7 Pipelines — 15 — 6 8 — — — Others 63 (7) 41 (5) 49 (10) 56 (5) 64 (2) 14 (0) 9 23 71 79 Total 420 (280) 516 (410) 696 (507) 798 (565) 706 (456) 196 (159) 158 354 785 839 Note: Figures in brackets represent quantum of orders announced (versus the reported number) Source: Company, Kotak Institutional Equities estimates Sweet spot may not be present in other areas particularly Government/PSU contracts Similar sweet spot does not seem to exist in other areas particularly in Government and PSU contracts. We highlight that business originating from these clients is highly competitive. L&T’s strike rate (orders won versus bids placed) from clients such as NPCIL (36%), NMDC (nil), ONGC (27%), NTPC (nil in bulk tender), etc. has been relatively low in the past 12-18 months. While balance sheet stress (on high debt levels) may inhibit some contractors from bidding for development projects, these players would still bid for cash contracts (which may in fact help relieve some of the balance sheet stress).