2 May 2018 Update Sector: Capital Goods Larsen & Toubro BSE SENSEX S&P CNX 35,160 10,739 Stock Info Bloomberg LT IN Equity Shares (m) 1,399.4 52-Week Range (INR) 1470 / 1108 1, 6, 12 Rel. Per (%) 0/9/3 M.Cap. (INR b) 1931.2 M.Cap. (USD b) 29.7 Avg Val, INRm 3243.0 Free float (%) 100.0 Financials Snapshot (INR b) Y/E Mar 2018 2019E 2020E Net Sales 1,201 1,365 1,455 EBITDA 132.5 160.6 170.0 PAT 68.0 80.6 97.6 EPS (INR) 48.6 57.6 69.8 Gr. (%) 14.8 18.5 21.2 BV/Sh (INR) 391.3 430.2 558.0 RoE (%) 13.0 14.0 14.1 RoCE (%) 8.3 9.9 9.9 P/E (x) 28.4 24.0 19.8 P/BV (x) 3.8 3.5 3.2 Shareholding pattern (%) As On Mar-18 Dec-17 Mar-17 Promoter 0.0 0.0 0.0 DII 38.5 40.1 38.8 FII 20.5 18.5 19.2 Others 41.0 41.4 42.1 FII Includes depository receipts Stock Performance (1-year) Larsen & Toubro Sensex - Rebased 1,525 1,350 1,175 1,000 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 CMP: INR1,400 TP: INR1,690 (+21%) Divests E&A business to Schneider Electric for INR140b In line with L&T s Lakshya programme to divest non-core assets Buy L&T signs agreement with Schneider Electric for sale of its Electrical & Automation segment. L&T has entered into a definitive agreement with Schneider Electric (India) Private Limited and Schneider Electric JV Holdings Limited for a divestment of its Electrical and Automation (E&A) segment for a cash consideration of INR140b. The deal does not include the marine switchgear and Servowatch Systems (primarily into marine automation) in the E&A segment. The deal is expected to close in 18 months from the date of signing of the agreement (1 st May, 2018) and is subject to receipt of the required regulatory approvals. The E&A segment accounted for ~4-5% of consolidated sales in FY18e and ~6% of consolidated EBITDA (See Exhibit 1 for detailed P/L of the E&A segment). The E&A segment is a debt free business with strong cash flow generation and EBITDA margins in the 14-15% margin range E&A segment primarily into switchgears and automation products; amongst the largest player in LV switchgear in India. The E&A business comprises two strategic Business Groups (SBGs) Products SBG and Projects SBG and offers a wide range of low and medium voltage switchgear, electrical systems, marine switchgear, industrial/ building automation solutions and metering solutions. Its key competitors include ABB, Siemens, Legrand, HPL Electric and Havells India. Its manufacturing facilities are located at Navi Mumbai, Ahmednagar, Vadodara, Coimbatore and Mysore in India as well as in Saudi Arabia, UAE, Kuwait, Malaysia, Indonesia and the UK. Sale of the E&A segment for a cash consideration of INR140b. At INR140b, the E&A segment is valued at 2.7x/2.6x/2.5x FY18e/19e/20e sales and 33x/31x/29x FY18e/19e/20e EPS. This is largely in line with its listed peers such as Havells, ABB, and Siemens (See Exhibit 2 and Exhibit 4 for valuations of the segment vs. listed peers). Revise up estimates for L&T in FY20/21 to factor in the E&A segment sale. We have assumed that the deal achieves closure in 1H20 (18 months from signing of the agreement). In our view, of the INR112b of cash consideration to be received by L&T post tax, a portion would be used to retire debt (~INR100b) while the balance (INR12b) used for funding growth in subsidiaries/strategic acquisitions. We revise up our FY20/21e EPS by 2% each and our SOTP based price target to INR1, 690 (E&C business at 24x FY20E EPS, to which we add INR520 for subsidiaries). Key risks to our rating include (a) a sharp slowdown in government spending and (b) a sharp fall in oil prices in the Middle East. Ankur Sharma Research Analyst (Ankur.VSharma@MotilalOswal.com); +91 22 6129 1556 Amit Shah Research Analyst (Amit.Shah@MotilalOswal.com); +91 22 6129 1543 Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on www.motilaloswal.com/institutional-equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.
Exhibit 1: L&T E&A segment P&L Description FY14 FY15 FY16 FY17 FY18 FY19E FY20E Sales 45,500 47,900 46,500 46,500 51,680 54,317 57,093 YoY (%) 5% -3% 0% 11% 5% 5% EBITDA 6,440 7,100 5,788 7,022 7,703 8,116 8,553 Margin (%) 14.2% 14.8% 12.4% 15.1% 14.9% 14.9% 15.0% Depreciation (1,016) (1,608) (1,461) (1,510) (1,586) (1,665) (1,748) PBT 5,424 5,492 4,327 5,512 6,117 6,451 6,805 Tax (1,790) (1,812) (1,428) (1,653) (1,835) (1,935) (2,042) PAT 3,634 3,680 2,899 3,858 4,282 4,516 4,764 Source: Company, MOSL Exhibit 2: Valuations for the E&A segment at INR140b cash consideration Valuations FY17 FY18 FY19 FY20 P/Sales 3.0 2.7 2.6 2.5 EV/EBITDA 19.9 18.2 17.3 16.4 P/E 36.3 32.7 31.0 29.4 P/B 5.8 5.7 5.4 5.2 Source: : Company, MOSL Exhibit 3: E&A segment pre-tax ROCE Description FY15 FY16 FY17 FY18 Segmental Assets 47,926 44,722 43,643 43,032 Less : Liabilities (19,069) (17,743) (19,357) (18,612) Capital Employed 28,856 26,978 24,286 24,420 Pre- tax ROCE (%) 19% 16% 23% 25% Source: Company, MOSL Exhibit 4: Comparison of valuations for the E&A segment to listed peers Description Price to Sales Price to Earnings FY17 FY18 FY19 FY20 FY17 FY18 FY19 FY20 L&T Electrical and Automation 3.0 2.7 2.6 2.5 36.3 32.7 31.0 29.4 Havells 5.6 4.2 1.8 1.5 57.2 49.1 40.0 32.2 ABB 3.3 3.1 2.5 2.2 76.7 68.4 46.3 39.3 Siemens 3.7 2.9 2.8 2.5 56.7 36.9 32.4 28.9 Median 3.5 3.0 2.5 2.3 57.0 43.0 36.2 30.8 Source: Company, MOSL Exhibit 5: Change in estimates incorporating the sale of the E&A segment Description New Estimates Old Estimates Change in Estimates FY18 FY19 FY20 FY21 FY20 FY21 FY20 FY21 Sales 1,201,131 1,364,520 1,455,278 1,561,609 1,483,825 1,621,626-1.9% -3.7% EBITDA 132,515 160,611 169,951 187,844 174,228 196,828-2.5% -4.6% Margin (%) 11.0% 11.8% 11.7% 12.0% 11.7% 12.1% -0.5% -0.9% Less: Interest (15,185) (30,614) (25,083) (19,552) (30,083) (29,552) -16.6% -33.8% Less: Depreciation (19,915) (22,093) (20,691) (20,396) (21,741) (22,099) -4.8% -7.7% Add: Other income 13,985 19,917 24,612 31,299 24,220 30,073 1.6% 4.1% PBT 111,401 127,821 148,788 179,195 146,623 175,249 1.5% 2.3% Tax (32,306) (35,790) (41,661) (50,175) (41,054) (49,070) 1.5% 2.3% Rate (%) 29% 28% 28% 28% 28% 28% 0.0% 0.0% PAT before minority interest 79,094 92,031 107,127 129,020 105,568 126,179 1.5% 2.3% Minority and Share of profit of associate (11,124) (11,475) (9,490) (8,290) (9,490) (8,290) 0.0% 0.0% PAT 67,970 80,556 97,637 120,730 96,078 117,889 1.6% 2.4% Source: MOSL, Company 2 May 2018 2
Well positioned to benefit from economic recovery Maintaining Buy A foreword on the long term industry view: The capex cycle in India peaked in FY13 when share of private sector stood at a high of ~60% of total projects under implementation. Since then the share of the private sector has been declining and is now down to 40% - in the meantime, government has stepped up infrastructure spending to offset the decline in private spending. This trend is starting to reverse - private sector project sanction too saw a surge of 92% to INR1.8t in FY17 after declining for 6 years and we expect ordering and capex to follow. L&T in that industry backdrop Five year strategic plan Lakshya FY16-21 in place: L&T has put in place its five year strategic plan Lakshya which focuses on a) Doubling sales to INR2t by FY21 b) Improving margins (ex-services) from 10% in FY16 to 11.2% in FY21. c) Value unlocking either by listing the asset or by divesting non-core assets d) Improve RoE s from 12% in FY16 to 18% in FY21. e) Bring down the working capital from 24% in FY16 to 18% by FY21. Successful implementation of the strategic plan would ensure healthy operational growth for L&T. Recent operational performance provides confidence on successful implementation of Lakshya: L&T s efforts to successfully implement Lakshya are visible in its recent performance on multiple fronts. L&T has been able to successfully bring down the net working capital to 20% in 2QFY18 from 24% in FY16. B) Operating margins (ex-services) have shown signs of pick up (11.2% in2qfy18). C) Listing of L&T Finance, IT and technology services and divestment of non-core assets like ( L&T cutting tools, EWAC alloys, L&T general insurance, Seawood retail mall, south city projects) We expect L&T to register 10% revenue growth over the FY17-21E with margin improvement of 200bps over the same period to 12.3%. Company s conscious efforts to bag orders with better margin profile, and cost control measures should ensure margin improvement going ahead. What it means for the target price 3-year view: Over the three year time frame we have valued L&T s core E&C business at 25x FY21E EPS (higher end of the last 5 year trading band of 20-25x given our premise of pick up in the private capex cycle supported by the government capex) and other business with historical industry average in which they operate which works out to INR1,820. This implies returns CAGR of 13% at L&T. 1-year view: While L&T has cut its order inflow guidance from earlier 10-12% to Zero to marginally positive for FY18. Order announcement from L&T for 3QFY18 (INR380b) is encouraging and can potentially lead to higher single digit order inflow growth for fy18. Furthermore, L&T has maintained its revenue growth guidance of 10-12% and margin improvement guidance of 25bps for FY18. Given operational performance improvement, better ordering visibility given pickup in economic activity, we have valued L&T on SoTP basis with target price of INR1,690. 2 May 2018 3
Key triggers Pick-up in private capex cycle supported by government capex Timely execution of strong order backlog that company has Divestment of the non-core assets and net working capital cycle improvement Key risk factors Delay in pickup of capex cycle recovery Delay in timely execution of the order backlog in hand Deterioration in the operational parameters Target price of INR1690; maintain Buy L&T is exposed to several levers across business/geographic segments and has emerged as the E&C partner of choice in India, which provides a robust foundation to capitalize on the next leg of investment cycle. Under its new five-year strategic plan to FY21, LT aims to: (a) grow sales at a 12-15% CAGR to reach INR2t by 2021; (b) increase margins to 11.2%, +120bp over FY16, driven by higher profitability in key manufacturing verticals (power, process, forgings and Katupalli yard) and hydrocarbons; (c) unlock value via asset sales to drive ROE to 18% from 12% in FY16; and (d) reduce working capital to 18% of sales from 24% currently. Manufacturing businesses (like Shipyard, Power BTG, and Forgings) also present interesting possibilities in the longer term. Many of these businesses are difficult to replicate and L&T is strongly positioned as a dominant player. Exhibit 6: L&T SOTP Description Construction Business Method Valuation multiple Value (INR b) Value (INR/sh) Rationale L&T Standalone Mar'20E PER (x) 24.0 1,631 1,165 Higher end of 5 year trading band of 20-25x L&T Hydrocarbons Mar'20E PER (x) 24.0 204 146 Service Segments L&T Infotech (84.6% stake) Mar'20E PER (x) 12.0 152 108 At par to mid tier IT companies; excl. stake sold via OFS L&T Technology Sevices(90% stake) Mar'20E PER (x) 12.0 97 70 At par to mid tier IT companies excl. stake sold via OFS Finance Sevices (67% stake) Mar '20E PBV (x) 3.0 232 166 3x P/BV on FY19 Sapura Shipping Mar '20E PBV (x) 1.5 0 0 L&T Realty Mar'20E PER (x) 15.0 41 29 Asset Ownership / Project Developer IDPL - Roads, Transmission Mar '20E PBV (x) 0.5 23 17 0.5x Book Value to capture the losses Hyderabad Metro Mar '20E PBV (x) 0.5 32 11 To account for losses in the Metro business Power Development Projects Mar '20E PBV (x) 1.0 31 22 At Book Value, given Case 2 bid Manufacturing Ventures Power Equipment Mar'20E PER (x) 15.0 30 21 Expect industry project awards to sustain at 5-7GW pa Shipbuilding Mar '20E PBV (x) 1.0 31 22 Increased possibility of Defence (Naval) orders Special Steel and Heavy Forgings Mar '20E PBV (x) 1.0 4 3 Possibility of Nuclear project awards to commence in FY19 Less: Holdco Discount of 20% -94 Total 2,511 1,688 2 May 2018 4
Financials and Valuations Income Statement (INR m) Y/E March 2013 2014 2015 2016 2017 2018E 2019E 2020E Net Revenues 744,980 851,284 920,046 1,019,753 1,100,110 1,201,131 1,364,520 1,455,278 Growth Rate (%) 16.0 14.3 8.1 10.8 7.9 9.2 13.6 6.7 Manufacturing Expenses 546,888 616,948 672,937 724,089 780,393 856,138 968,126 1,034,988 Staff Cost 62,446 80,276 79,222 133,308 138,531 147,410 167,462 178,601 S G &A Expenses 36,359 46,517 54,531 57,728 70,440 65,068 68,322 71,738 EBITDA 99,287 107,543 113,356 104,628 110,747 132,515 160,611 169,951 Change (%) 14.3 8.3 5.4-7.7 5.8 19.7 21.2 5.8 Adj EBIDTA 99,287 107,543 113,356 104,628 110,747 132,515 160,611 169,951 EBITDA Margin (%) 13.3 12.6 12.3 10.3 10.1 11.0 11.8 11.7 Depreciation 16,371 14,458 26,225 17,867 23,699 19,915 22,093 20,691 EBIT 82,917 93,085 87,131 86,761 87,048 112,600 138,518 149,260 Net Interest 21,243 31,414 28,507 16,551 13,398 15,185 30,614 25,083 Other Income 10,557 9,819 10,072 9,044 14,010 13,985 19,917 24,612 Profit before Tax 72,231 71,490 68,696 79,254 87,659 111,401 127,821 148,788 Tax 23,790 26,076 22,836 24,848 20,066 32,306 35,790 41,661 Effective Tax Rate (%) 32.9 36.5 33.2 31.4 22.9 29.0 28.0 28.0 Reported Profit 51,808 48,817 49,337 55,348 68,808 80,324 92,031 219,127 Less:Addl tax on dividend by Subs 130 208 0 0 0 0 0 0 Less: Minority Interest 722-382 1,710 3,118 4,443 6,096 6,478 7,050 Add: Profits of Associates 384 93 21-9,902-3,953-5,028-4,997-2,441 EO Adjustments 3,368 3,402 3,477 942 1,214 1,230 0 112,000 Adjusted Profit 47,973 45,680 44,171 41,387 59,198 67,970 80,556 97,637 Growth (%) 5.3-4.8-3.3-6.3 43.0 14.8 18.5 21.2 Cons. Profit (Reported) 51,341 49,083 47,648 42,329 60,412 69,200 80,556 209,637 Balance Sheet (INR m) Y/E March 2013 2014 2015E 2016 2017E 2018E 2019E 2020E Equity Capital 1,231 1,854 1,859 1,863 1,866 1,866 1,866 1,866 Reserves and Surplus 337,366 375,262 410,222 439,941 500,299 545,684 600,186 778,959 Net Worth 338,597 377,116 412,081 441,804 502,165 547,550 602,052 780,825 Debt 619,936 801,529 767,297 881,352 939,761 1,041,696 1,044,613 947,779 Deferred Tax Liability 1,837 3,375-3,504-7,364-11,252-11,252-11,252-11,252 Minority Interest 26,529 31,792 19,706 28,928 35,636 41,732 48,210 55,259 Capital Employed 986,899 1,213,812 1,195,580 1,344,719 1,466,310 1,619,726 1,683,622 1,772,612 Gross Fixed Assets 379,822 411,347 168,322 167,706 171,779 181,779 171,779 161,779 Less : Depreciation 75,670 88,824 6,555 23,518 38,375 58,290 80,383 101,074 Add : Capital WIP 113,068 143,237 103,416 151,651 167,374 167,374 167,374 167,374 Net Fixed Assets 417,220 465,760 265,184 295,839 300,778 290,864 258,770 228,079 Investments 87,675 81,090 113,089 110,791 197,530 217,530 217,530 217,530 Inventory 51,874 55,275 59,812 48,542 41,397 45,198 51,347 54,762 Sundry Debtors 230,149 263,846 222,544 260,250 279,696 328,415 373,090 397,905 Cash & Bank 35,715 40,966 44,126 53,899 55,725 129,763 179,469 267,660 Loans & Advances 84,536 134,755 13,491 16,889 19,547 21,342 24,245 25,857 Other Current Assets 201,930 254,934 416,488 481,865 488,977 550,333 625,194 666,778 Current Assets 924,213 1,150,574 1,313,997 1,527,390 1,605,954 1,807,865 1,998,603 2,170,914 Current Liabilities 442,209 483,612 496,690 589,299 637,950 696,532 791,281 843,911 Net Current Assets 482,004 666,962 817,307 938,092 968,004 1,111,332 1,207,322 1,327,003 Capital Deployed 986,899 1,213,812 1,195,579 1,344,722 1,466,312 1,619,726 1,683,623 1,772,612 E: MOSL Estimates 2 May 2018 5
Financials and Valuations Ratios Y/E March 2013 2014 2015 2016 2017E 2018E 2019E 2020E Basic (INR) Standalone EPS Adj 32.6 35.0 33.6 31.7 32.6 39.3 45.4 53.7 Growth (%) 3.7 7.4-4.2-5.5 2.7 20.7 15.4 18.5 Consolidated EPS Adj 34.3 32.6 31.6 29.6 42.3 48.6 57.6 69.8 Growth (%) 5.3-4.8-3.3-6.3 43.0 14.8 18.5 21.2 Con. EPS (Fully Diluted) 34.3 32.6 31.6 29.6 42.3 48.6 57.6 69.8 Growth (%) 5.3 42.8-3.3-6.3 43.0 14.8 18.5 21.2 Cash EPS 46.0 43.0 50.3 42.3 59.2 62.8 73.4 84.6 Book Value 242.0 269.5 294.5 315.7 358.8 391.3 430.2 558.0 Dividend Per Share 7.6 9.4 8.7 12.5 14.0 14.2 16.3 19.3 Div. Payout (Incl. Div Tax ) % 22.2 28.9 27.5 42.3 33.2 29.1 28.4 27.7 Valuation (x) P/E (Standalone) 42.4 35.1 35.1 30.4 P/E (Consolidated) 32.6 28.4 24.0 19.8 P/E (Consolidated) (Fully Diluted) 32.6 28.4 24.0 19.8 Price / CEPS 23.3 22.0 18.8 16.3 EV/EBITDA 25.4 21.5 17.4 15.4 EV/ Sales 2.7 2.6 2.4 2.0 Price / Book Value 4.4 3.8 3.5 3.2 Dividend Yield 1.0 1.0 1.2 1.4 Return Ratio (%) RoE 15.3 12.8 11.2 9.7 12.5 13.0 14.0 14.1 RoCE 8.3 7.2 7.7 7.4 8.0 8.3 9.9 9.9 Turnover Ratios Debtors (Days) 112.8 113.1 88.3 93.2 92.8 99.8 99.8 99.8 Inventory (Days) 25.4 23.7 23.7 17.4 13.7 13.7 13.7 13.7 Asset Turnover (x) 0.8 0.7 0.8 0.8 0.8 0.7 0.8 0.8 Leverage Ratio Current Ratio (x) 2.1 2.4 2.6 2.6 2.5 2.6 2.5 2.6 D/E (x) 1.0 1.2 0.8 0.8 0.7 0.8 0.7 0.4 Cash Flow Statement (INR m) Y/E March 2013 2014 2015 2016 2017E 2018E 2019E 2020E PBT before EO Items 52,057 49,020 47,648 42,329 60,412 69,200 80,556 209,637 Add : Depreciation 16,371 14,458 26,225 17,867 23,699 19,915 22,093 20,691 Change in diff tax liability -43,158 1,538-6,879-3,860-3,888 0 0 0 (Inc)/Dec in WC -84,641-179,708-147,185-111,011-28,086-69,291-46,283-31,490 CF from Operations -59,372-114,692-80,191-54,675 52,138 19,824 56,366 198,838 (Inc)/Dec in FA -90,670-62,998 174,351-48,523-28,638-10,000 10,000 10,000 Free Cash Flow -150,042-177,690 94,161-103,198 23,499 9,824 66,366 208,838 (Pur)/Sale of Investments 220 6,585-31,999 2,298-86,740-20,000 0 0 Advances to subs CF from Investments -90,237-56,413 142,352-46,225-115,378-30,000 10,000 10,000 (Inc)/Dec in Net Worth 5,057 4,821 1,419 7,731 22,768-1,230 0 0 (Inc)/Dec in Debt 148,436 181,593-34,233 114,058 58,408 101,933 2,917-96,834 Change in Minority Interest 8,994 5,263-12,086 9,222 6,708 6,096 6,478 7,050 Dividend Paid -12,385-15,322-14,103-20,337-22,818-22,586-26,055-30,863 CF from Fin. Activity 150,102 176,355-59,002 110,674 65,065 84,214-16,660-120,648 Inc/Dec of Cash 493 5,251 3,160 9,774 1,825 74,038 49,707 88,191 Add: Beginning Balance 35,222 35,715 40,966 44,126 53,900 55,725 129,763 179,469 Closing Balance 35,715 40,966 44,126 53,900 55,725 129,763 179,469 267,660 E: MOSL Estimates 2 May 2018 6
N O T E S 2 May 2018 7
Explanation of Investment Rating Investment Rating Expected return (over 12-month) BUY >=15% SELL < - 10% NEUTRAL > - 10 % to 15% UNDER REVIEW Rating may undergo a change NOT RATED We have forward looking estimates for the stock but we refrain from assigning recommendation *In case the recommendation given by the Research Analyst becomes inconsistent with the investment rating legend, the Research Analyst shall within 28 days of the inconsistency, take appropriate measures to make the recommendation consistent with the investment rating legend. Disclosures: The following Disclosures are being made in compliance with the SEBI Research Analyst Regulations 2014 (herein after referred to as the Regulations). Larsen & Toubro Motilal Oswal Securities Ltd. (MOSL) is a SEBI Registered Research Analyst having registration no. INH000000412. 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Registration details of group entities.: MOSL: SEBI Registration: INZ000158836 (BSE/NSE/MCX/NCDEX); CDSL: IN-DP-16-2015; NSDL: IN-DP-NSDL-152-2000; Research Analyst: INH000000412. AMFI: ARN 17397. Investment Adviser: INA000007100.IRDA Corporate Agent-CA0541. Motilal Oswal Asset Management Company Ltd. (MOAMC): PMS (Registration No.: INP000000670) offers PMS and Mutual Funds products. Motilal Oswal Wealth Management Ltd. (MOWML): PMS (Registration No.: INP000004409) offers wealth management solutions. *Motilal Oswal Securities Ltd. is a distributor of Mutual Funds, PMS, Fixed Deposit, Bond, NCDs, Insurance and IPO products. * Motilal Oswal Commodities Broker Pvt. Ltd. offers Commodities Products. * Motilal Oswal Real Estate Investment Advisors II Pvt. Ltd. offers Real Estate products. * Motilal Oswal Private Equity Investment Advisors Pvt. Ltd. offers Private Equity products 2 May 2018 8