LARSEN & TOUBRO Geared up for a long haul

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1 VISIT NOTE LARSEN & TOUBRO Geared up for a long haul India Equity Research Engineering and Capital Goods We met up with L&T management recently and came back positive on its medium to long term business potential and new business initiatives. RoCE improvement in focus; aims to leverage new capacities L&T targets to achieve an improvement in RoCEs over next 2 3 years by exiting noncore businesses which are not scalable, value unlocking in select developmental projects and optimizing the current manufacturing base in ship building, defense, heavy forgings and power equipment. L&T expects to utilize its upcoming shipyard for both defense and commercial vessels, and is eyeing improved ordering from FY14E. It currently has INR15bn worth of order book in this segment. In switchgears, L&T has incurred capex for new switchgears plant (at Baroda) and new control panel plants (LV & MV) at Ahmednagar and Coimbatore which will help reduce overall costs and arrest margin decline in the EBG business. Growth guidance reiterated; no major capex incrementally L&T has guided for a 15% 20% growth in OI and 15% growth in revenue for FY13E (which the management hopes to maintain as of now). Outlook for hydrocarbons, power T&D, railways, etc remains healthy, adding to near term order book growth visibility. The company has incurred INR70bn+ in the last 2 3 years for building manufacturing capabilities in power equipment, forgings, ship building etc hence does not expect any fresh capacity addition incrementally other than maintenance capex. Outlook and valuations: Positioned for growth; maintain BUY Our recent visit to the company boosted our confidence on the order intake and earnings growth outlook in the near to medium term. Order inflows in power EPC, ship building, defense and heavy forgings would help L&T reposition itself over the long run. Any major traction on the policy front clearly poses a major upside risk to our growth assumptions for FY13E 14E. We reiterate our positive stance on L&T for its long term positioning in the industrial and infrastructure space, scalability of current businesses and the sustained focus on profitability. We maintain our BUY/SO rating with a revised TP of INR 1587 (earlier 1528). We maintain our parent valuation at INR1278/share. Financials SA Year to March FY11 FY12 FY13E FY14E Revenues (INR mn) 439, , , ,380 Rev. growth (%) EBITDA (INR mn) ,098 79,766 Net profit (INR mn) Share outstanding (mn) EPS (INR) EPS growth (%) (8.6) Diluted P/E (x) EV/EBITDA (x) ROE (%) Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. EDELWEISS 4D RATINGS Absolute Rating Rating Relative to Sector Risk Rating Relative to Sector Sector Relative to Market BUY Edelweiss Securities Limited Outperformer Medium MARKET DATA (R: LART.BO, B: LT IN) Equalweight CMP : INR 1,409 Target Price : INR 1, week range (INR) : 1,673 / 969 Share in issue (mn) : M cap (INR bn/usd mn) : 865/ 15,671 Avg. Daily Vol.BSE/NSE( 000) : 2,494.2 SHARE HOLDING PATTERN (%) Current Q4FY12 Q3FY12 Promoters % MF's, FI's & BK s FII's others * Promoters pledged shares (% of share in issue) PRICE PERFORMANCE (%) Stock Nifty : NIL EW Construction Index 1 month (3.5) months months (18.6) 4.2 (4.9) Amit Mahawar amit.mahawar@edelcap.com Rahul Gajare rahul.gajare@edelcap.com Swarnim Maheshwari swarnim.maheshwari@edelcap.com September 12, 2012

2 Engineering and Capital Goods New mfg capacities: Weak in near term, but scalable over long term Eyeing EPC based power projects for Hazira facility: L&T has limited revenue visibility for manufacturing plants at Hariza for revenues beyond FY14E given the zero BTG order inflows in FY12. It recently commissioned the critical piping and Electro Static Precipitators (ESP) plant and could now deliver more than 75% of the scope in a power plant on a turnkey basis. On the opportunity side, L&T expects projects worth 8GW on EPC basis and 6GW on BTG basis to come up for bidding over the next few quarters. Ship building, defense to gain size going ahead: L&T expects to see an improved traction in ship building from FY14E given that it has entered into a JV with Mazgaon Dock for submarines and expects major ordering potential for private sector in defense vessels and submarine from Ministry of defense (Indian Navy). The company currently has INR15bn worth of orders in hand for Interceptor boats for the Indian Navy and few more for commercial vessels. Other key highlights With NHAI expected to award 9500 km of road projects during FY13E (including km of EPC projects), L&T targets to opt for higher share of EPC projects. L&T expects an increased traction in Western DFCC towards 2HFY13E, and expect at least two packages worth INR 80 bn to be awarded in FY13E. L&T Sojitz consortium is one of the two pre qualified entities for Western DFCC. Apart from routine railway capex, L&T expects km of additional private railway siding business to accrue during the current year. Current order book of INR 15 bn in ship building would be executed from Katupalli & Hazira equally. L&T expects to bag Submarine orders from Mazgaon dock from FY14E onwards. L&T expects Hydrocarbons to see a strong growth in fresh order intake during FY13E and expects a 30 %+ growth in Hydrocarbons project awards this year.. 2 Edelweiss Securities Limited

3 Larsen & Toubro Segment wise Order intake assumption for L&T Table 1: Order intake assumption for FY13E and FY14E (All figures in INR bn) FY12 FY13E FY14E Comments Process Spending in metals& mining space is expected to remain weak in the near term. Power T&D Middle East L&T increased focus in key marketrs like Qatar/Oman/Abu Dhabi has helped it gain significant traction in Middle East T&D inflows. We expect the growth momentum to continue. T&D India Strong ordering momentum led by PGCIL has helped the company in gaining significant momentum which is likely to continue. BoP/Gas/EPC etc We are assuming no gas EPC orders in FY13. BTG We have assumed atleast one EPC contract through the developmental project in FY13E & FY14E Hydrocarbons India Expect growth momentum to continue in domestic Oil& Gas Industry. We have not build any orders from fertlizer sector pending policy clarity. Exports We expect order inflow traction to improve in the coming quarters given historical pattern of middle east ordering in 2H of fiscal year. Infrastructure Factories & Buildings We expect 5% growth in F&B segment. Railways (DFC+Metro) We expect Western DFCC project award before Q4FY13 where L&T consortium is one of the two qulified entities. Also, private Railway sidings will be an additional opportunity ( kMs). Roads We expect NHAI to award Kms EPC projects during FY13E. Airport/Urban Infra We don t expect any significant ordering in this space in the near term. Water L&T has shown good traction in municipality orders in the last 12 months and we expect this segment to do well in coming years, given strong project award pipeline. Developmental Projects We expect L&T to go slow in new development projects Others TOTAL Source: Industry, Edelweiss research 3 Edelweiss Securities Limited

4 Engineering and Capital Goods Table 2: SOTP valuation Valuation methodology Multiple L&T's Value Per share Remark stake (%) (INR mn) (INR) L&T Parent PE ,403 1,278 Assigning 15% discount to avg 1 Yr Fwd FY05 12 PE on FY14E EPS (Ex dividend from subsidairies) L&T MHI (BTG JVs) PE 51 We assign a nil value to this subsidiary L&T Infotech PER , In line with other mid cap IT companies L&T Finance Holdings 82 51, % discount to market cap L&T IDPL P/BV , x book Others PE , % discount to L&T standalone valuations Total 970,296 1,587 Chart 1: L&T 1 year fwd PE band 60.0 Source: Edelweiss research Average at 19.2x (FY05-12) (x) Sep-04 Jan-05 May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Source: Edelweiss research 4 Edelweiss Securities Limited

5 Company Description Larsen & Toubro L&T, headquartered in Mumbai, is a technology driven engineering and construction company, and one of the largest companies in India s private sector. It has additional interests in manufacturing, services, and information technology. A strong customerfocused approach and constant quest for top class quality has enabled the company attain and sustain leadership in major lines of businesses over seven decades. L&T has international presence with a global spread of offices. L&T has recently build up a world class BTG facility in Hazira which can cater upto 5 sets per year. With factories and offices located around the country, further supplemented by a wide marketing and distribution network, L&T s image and equity extend to virtually every district of India. The company aspires to increase its in house manufacturing scope through its entry into power equipment (mainly BTG) manufacturing. Investment Rationale Best equipped to ride infrastructure capex cycle: L&T is India s largest infrastructure and EPC company with presence across major verticals like process, hydrocarbons, power, core infrastructure like roads, ports, bridges, industrial structures etc. Diversified business dominance: L&T has a dominant position and market share in most operating verticals, be it oil & gas, process projects, roads, bridges, or industrial structures. It has dedicated key business divisions with skilled manpower. New business verticals to enhance revenue base: We expect Ship building, Power BTG & Nuclear tie up to enhance revenue in the future. Key Risks Economy slowdown: Being a play across the India growth spectrum, any slowdown in the broad economy will impact L&T s operations. Also, given that a large part of the infrastructure capex is government driven, any political instability could impact the roll out plans and, in turn, the company s growth plans. Raw material costs and execution risks: Any sudden surge in prices of base raw material comprising steel, aluminum, cement etc., could detrimentally affect the company s margin/operations, despite most contracts having a built in price escalation clause. Also, given the scale of projects being executed, any execution delay could cost the company dearly. 5 Edelweiss Securities Limited

6 Engineering and Capital Goods Financial Statements (Standalone) Key Assumptions Macro GDP(Y o Y %) Inflation (Avg) Repo rate (exit rate) USD/INR (Avg) Company Order inflow assumptions Process 90, ,630 77,631 65,210 71,731 Oil & Gas 139,144 55,838 77,631 93, ,473 Power 229, , , , ,479 Infrastructure 187, , , , ,251 Others 48,700 55,838 63,517 66,693 70,027 Total 695, , , , ,962 Income from operations 370, , , , ,380 Direct costs 285, , , , ,167 Employee costs 23,791 28,845 36,635 41,252 46,347 Other expenses 13,789 19,903 22,043 28,908 33,100 Total operating expenses 322, , , , ,614 EBITDA 47,394 55,984 60,299 69,098 79,766 Depreciation and amortisation 3,797 5,624 6,995 8,774 9,566 EBIT 43,597 50,360 53,304 60,324 70,201 Interest expenses 5,053 6,474 6,681 9,082 10,676 Other income 20,250 14,430 15,930 14,895 15,008 Profit before tax 58,794 58,316 62,553 66,136 74,533 Provision for tax 16,409 19,459 18,538 21,627 24,372 Core Profit 42,385 38,858 44,015 44,510 50,161 Extraordinary items/exceptional items 1, Profit after tax 43,755 39,578 44,565 44,510 50,161 Adjusted net profit 42,385 38,858 44,015 44,510 50,161 Diluted equity shares (mn) EPS (INR) fully diluted Dividend per share Dividend payout (%) Common size metrics as % of net revenues Direct cost EBITDA margins Core net profit margins Growth metrics (%) Revenues EBITDA EPS 55.1 (8.6) Edelweiss Securities Limited

7 Larsen & Toubro Balance sheet (INR mn) As on 31st March FY10 FY11 FY12 FY13E FY14E Equity capital 1,204 1,218 1,225 1,225 1,225 Employee stock option O/S 251 Reserves & surplus 178, , , , ,691 Net ESOP charges 2,839 3, Shareholders funds 183, , , , ,915 Secured loans 9,557 10,630 14,533 21,033 27,533 Unsecured loans 58,451 60,981 84,424 86,424 87,424 Borrowings 68,008 71,611 98, , ,958 Sources of funds 251, , , , ,873 Gross block 72,901 89, , , ,341 Depreciation 17,985 23,125 29,426 37,177 46,742 Net block 54,916 66,442 75,938 82,164 82,598 Capital work in progress 8,742 8,139 7,587 7,687 7,787 Total fixed assets 63,658 74,581 83,525 89,851 90,385 Investments 137, , , , ,719 Inventories 14,154 15,772 17,766 23,087 25,158 Sundry debtors 111, , , , ,774 Cash and equivalents 14,319 17,304 17,781 22,466 26,309 Loans and advances 59,975 81,887 91,280 95, ,429 Other current assets 63, , , , ,117 Total current assets 263, , , , ,788 Sundry creditors and others 190, , , , ,818 Provisions 21,884 22,334 23,871 23,871 23,871 Total CL & provisions 212, , , , ,689 Net current assets 51,188 71, , , ,099 Net deferred tax (774) (2,635) (1,330) (1,330) (1,330) Uses of funds 251, , , , ,873 Adjusted BV per share (INR) Free cash flow Net profit 43,755 39,578 44,565 44,510 50,161 Depreciation 3,797 5,624 6,995 8,774 9,566 Others (10,306) (3,817) (5,666) 9,082 10,676 Gross cash flow 37,246 41,385 45,894 62,366 70,402 Less:Changes in WC (17,582) 2,772 35,077 27,007 28,290 Operating cash flow 54,828 38,613 10,816 35,359 42,112 Less: Capex 15,598 15,468 15,971 15,100 10,100 Free cash flow 39,230 23,145 (5,155) 20,259 32,012 Cash flow metrices Operating cash flow 54,828 38,613 10,816 35,359 42,112 Financing cash flow 12,456 (11,248) 10,156 (10,575) (13,169) Investing cash flow (62,008) (24,380) (19,223) (20,100) (25,100) Net cash flow 5,275 2,985 1,750 4,685 3,843 Capex (15,598) (15,468) (15,971) (15,100) (10,100) Dividends paid (7,192) (8,670) (9,996) (9,993) (9,993) 7 Edelweiss Securities Limited

8 Engineering and Capital Goods Profitability & liquidity ratios ROAE (%) (on adjusted profits) ROACE (%) Inventory days Debtors days Payable days Cash conversion cycle (94) (129) (125) (106) (91) Current ratio Debt/EBITDA Interest coverage Fixed assets t/o (x) Debt/equity Adjusted debt/equity Operating ratios Total asset turnover Fixed asset turnover Equity turnover Valuation parameters Diluted EPS (INR) Y o Y growth (%) 55.1 (8.6) CEPS Diluted P/E (x) Price/BV (x) EV/Sales (x) EV/EBITDA (X) Dividend yield (%) Edelweiss Securities Limited

9 Larsen & Toubro Financial Statements (Consolidated) Income statement (INR mn) Income from operations 439, , , , ,055 Direct costs 323, , , , ,170 Employee costs 30,654 38,020 49,950 57,630 65,551 Other Expenses 21,246 30,553 33,297 35,456 37,208 Total operating expenses 375, , , , ,930 EBITDA 64,398 76,910 87,700 96, ,126 Depreciation & Amortization 9,793 12,443 15,803 18,494 19,227 EBIT 54,605 64,467 71,897 78,036 89,898 Other income 7,585 11,153 8,290 8,352 9,012 Interest expenses 6,919 8,309 11,019 12,012 13,626 Profit before tax 55,271 67,312 69,167 74,376 85,285 Provision for tax 20,388 23,479 22,912 24,693 28,144 Net profit 34,884 43,833 46,255 49,683 57,141 Extraordinary income/ (loss) 19, Profit After Tax 54,423 44,552 46,823 49,683 57,141 Minority interest ,029 Share in profit of associates 1, ,303 1,482 Profit after minority interest 54,508 44,637 46,937 50,092 57,594 Shares outstanding (mn) Diluted EPS (INR) Dividend payout (%) Common size metrics as % of net revenues Operating expenses EBITDA margins Net profit margins Growth ratios (%) Rev. growth (%) EBITDA Net profit Edelweiss Securities Limited

10 Engineering and Capital Goods Balance sheet (INR mn) As on 31st March FY10 FY11 FY12 FY13E FY14E Equity capital 1,204 1,218 1,225 1,225 1,225 Employee stock option O/S 3,244 4,139 Reserves & surplus 205, , , , ,831 Shareholders funds 209, , , , ,056 Minority interest (BS) 10,873 10,260 17,535 18,429 19,457 Secured loans 141, , , , ,420 Unsecured loans 104,214 93, , , ,071 Borrowings 246, , , , ,491 Deferred liability 45,117 44,177 44,177 44,177 Sources of funds 466, , , , ,181 Gross block 161, , , , ,189 Depreciation (37,476) (48,975) (63,570) (66,684) (85,912) Net block 123, , , , ,277 Capital work in progress 66, , , , ,127 Total fixed assets 189, , , , ,404 Investments 99,279 92,158 87,895 87,895 87,895 Inventories 23,782 30,403 42,299 55,273 63,212 Sundry debtors 125, , , , ,839 Cash and equivalents 33,216 36,454 33,786 23,464 32,270 Loans and advances 160, , , , ,567 Other current assets 74, , , , ,424 Total current assets 417, , , , ,312 Sundry creditors and others 212, , , , ,137 Provisions 24,743 24,126 26,553 9,023 9,474 Total current liabilities & provisions 237, , , , ,611 Net current assets 179, , , , ,700 Net Deferred tax (1,530) (3,109) (818) (818) (818) Uses of funds 466, , , , ,181 Book value per share (INR) Free cash flow (INR mn) Net profit 54,508 44,637 46,937 50,092 57,594 Depreciation 9,793 12,443 15,803 18,494 19,227 Deferred tax (1,530) (3,109) Others (32,582) (62,184) (68,817) 12,907 14,655 Gross cash flow 30,188 (8,214) (6,077) 81,492 91,476 Less: Changes in WC 28,318 7,943 57,323 70,279 57,069 Operating cash flow 21,513 (16,156) (63,400) 11,213 34,407 Less: Capex 44,800 68,661 71,039 18,500 14,500 Free cash flow (23,287) (84,817) (134,440) (7,287) 19,907 Cash flow metrics Operating cash flow 21,513 (16,156) (63,400) 11,213 34,407 Investing cash flow (52,703) (59,353) (58,642) (18,500) (14,500) Financing cash flow 50,099 78, ,815 (3,036) (11,100) Net cash flow 18,909 3,239 (1,227) (10,322) 8,806 Capex (44,800) (68,661) (71,039) (18,500) (14,500) Dividends paid (7,528) (8,828) (8,594) (9,023) (9,474) 10 Edelweiss Securities Limited

11 Larsen & Toubro Peer comparison valuation PE (x) P/BV (x) ROE (%) Name of the companies Price (KRW) Market cap (USD mn) 2013E 2014E 2013E 2014E 2013E 2014E Hyundai Heavy 218,500 15, Samsung Engineering 177,500 6, L&T (INR) 1,409 15, Source: Bloomberg, Edelweiss research 11 Edelweiss Securities Limited

12 Engineering RATING and & Capital INTERPRETATION Goods Company Absolute reco Relative reco Relative risk Company Absolute reco Relative reco Relative Risk ABB India REDUCE SU L Bajaj Electricals BUY SO M BGR Energy REDUCE SU M Bharat Electronics BUY SO H Bharat Heavy Electricals HOLD SP L Crompton Greaves BUY SO M Cummins India BUY SO L Havells India BUY SO M Jyoti Structures HOLD SP M Kalpataru Power HOLD SP M KEC International BUY SO M Larsen & Toubro BUY SO M Siemens HOLD SO L Sterlite Technologies HOLD SP H Techno Electric & Engineering BUY SO M Thermax HOLD SP L Voltamp Transformers REDUCE SU M Voltas HOLD SP L ABSOLUTE RATING Ratings Expected absolute returns over 12 months Buy More than 15% Hold Between 15% and - 5% Reduce Less than -5% RELATIVE RETURNS RATING Ratings Sector Outperformer (SO) Sector Performer (SP) Criteria Stock return > 1.25 x Sector return Stock return > 0.75 x Sector return Stock return < 1.25 x Sector return Sector Underperformer (SU) Stock return < 0.75 x Sector return Sector return is market cap weighted average return for the coverage universe within the sector RELATIVE RISK RATING Ratings Low (L) Medium (M) High (H) Criteria Bottom 1/3rd percentile in the sector Middle 1/3rd percentile in the sector Top 1/3rd percentile in the sector Risk ratings are based on Edelweiss risk model SECTOR RATING Ratings Overweight (OW) Equalweight (EW) Criteria Sector return > 1.25 x Nifty return Sector return > 0.75 x Nifty return Sector return < 1.25 x Nifty return Underweight (UW) Sector return < 0.75 x Nifty return 12 Edelweiss Securities Limited

13 Larsen & Toubro Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai Board: (91 22) , Vikas Khemani Head Institutional Equities Nischal Maheshwari Co Head Institutional Equities & Head Research Nirav Sheth Head Sales Coverage group(s) of stocks by primary analyst(s): ABB India, BGR Energy, Bharat Electronics, Bharat Heavy Electricals, Bajaj Electricals, Crompton Greaves, Havells India, Jyoti Structures, KEC International, Cummins India, Kalpataru Power, Larsen & Toubro, Siemens, Sterlite Technologies, Techno Electric & Engineering, Thermax, Voltamp Transformers, Voltas Recent Research Date Company Title Price (INR) Recos 10 Sep 12 Blue Star More pain before gain; Visit Note 04 Sep Aug 12 KEC International Bharat Electronics Changing course; time to BUY; Visit Note Sustaining ace defence play tag ; Visit Note 173 Not Rated 55 Buy 1258 Buy Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Buy Hold Reduce Total Rating Interpretation Rating Expected to Rating Distribution* * 1 stocks under review > 50bn Between 10bn and 50 bn < 10bn Market Cap (INR) Buy Hold Reduce appreciate more than 15% over a 12 month period appreciate up to 15% over a 12 month period depreciate more than 5% over a 12 month period 13 Edelweiss Securities Limited

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