The Hindu Business Line : Larsen & Toubro: Hold

SHAREHOLDERS of Larsen & Toubro can hold the stock till the process of de-merger is complete and the two main businesses — engineering and construction, and cement — are listed as separate companies.

This may, however, be delayed by shareholder activism (see related story in "Eye on the Market''). There may be a downside element linked to delays in the completion of legal formalities.

Shareholders will however, be better off taking such declines in their stride. Any hope of decline from the present price levels could be used to take exposures in the stock. A look at the key businesses on the eve of the demerger.

Engineering and construction: The focus is likely to be on this line of business for a number of reasons:

The healthy level of profitability that this business enjoys; the diversified nature of L&T's businesses, which had affected the valuation enjoyed by it over the past decade, would be a thing of the past.

The capital reduction from Rs 248 crore to Rs 25 crore, which is now a wealth-neutral exercise, may unlock value over the long term as the stock may seek a higher valuation.

The likelihood of enhanced investor interest, especially institutions, on a pure engineering and construction play, and

The consistent growth in revenues and earnings over a long period, numbers that carry credibility and professional management that have been a key factor in the company's strong showing over the years.

The revenues of L&T's engineering and construction business are likely to grow 30-35 per cent.

The revenues may be about Rs 9,500 crore. If L&T manages to notch up margins in line with FY 03 or even a percentage lower, the engineering and construction business may show per share earnings of between Rs 37 and Rs 44.

The smart rise of 75 per cent in the order-book position could ensure that revenue and earnings growth remains healthy over the next couple of years.

With the industrial and services economy buoyant, the thrust on infrastructure projects, and the enhanced spending on capital goods, there could be further accretion to the already-strong order book. L&T's strengths in the infrastructure sector, a stronger balance-sheet and the joint-ventures that ensure expertise in niche areas, are also likely to aid this process.

In this backdrop, this business of L&T is likely to emerge as a top quality exposure to the engineering and construction sector along with the likes of ABB, BHEL, Siemens and Thermax.

The L&T stock may, however, command a lower price earnings multiple compared to the engineering majors, to factor in the lower profitability in the construction business.

Given the shareholding pattern, the possibility of a friendly or hostile bid may also remain a factor in the pricing of the stock.

The stake of about 15 per cent that would be owned by an employees' trust of L&T is unlikely to deter serious bidders. Any move on this front would, however, take place only over the long term.

Slack in cement: During the first three quarters of FY 04 as well as in FY 03, the cement business generated moderate earnings before interest. If the interest element is factored in, there is a splash of red. This, however, does not reduce its attractiveness for Grasim.

Given the latter's strength in debt management and the likely improvement in pricing power in the hands of producers over the next two-three years, L&T's cement business may get a coat of black sooner than appears likely now.

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