The Hindu Business Line : L&T: Hold

SHAREHOLDERS of Larsen & Toubro can retain their holdings in the stock. Despite the rich valuations and inconsistent order flows seen in FY-05, we remain positive on the company's ability to capitalise on imminent macro opportunities. At Rs 1,256, the stock trades at a price-earnings multiple of 23 times FY-05 consolidated earnings after excluding income from the sale of UltraTech Cement shares.

Recovery in order-book and margins

L&T's engineering and construction segment, which contributes 85 per cent of total sales, experienced a sluggish phase in terms of order-books for the first three quarters of FY-05 and reflected a negative growth compared to the respective previous quarters. This trend was, however, reversed in the fourth quarter of FY-05 with a near-doubling of the order-book figure, year-on-year (Y-O-Y) basis. The current pace of order flows can be expected to support topline and earnings growth.

Another cause for concern in the last fiscal was the declining operating margins on increased input costs and a number of fixed price contracts. The company was, however, been able to redeem this situation partially in the fourth quarter. Improved resource utilisation reflected by an asset turnover ratio of 2.5, also helped mitigate the risk of falling margins.

Macro opportunities

The domestic situation is promising. The enhanced government focus for all-round economic growth is reflected in the enhanced allocation for infrastructure in the last Budget and in the Tenth Plan. There is a spurt in the number of orders released in the water and road segment.

L&T's recent contracts for the greater Bangalore water supply scheme and road projects in Haryana and Rajasthan suggest that the company is actively capitalising on order flows from the government. However, with an upsurge in the number of players eligible to contract projects in the road and water sectors, L&T can be expected to face stiff competition.

In the non-government space, with most process industries reaching near full-capacity utilisation there has been a surge in expansion activities especially in steel, aluminium and hydrocarbon sector.

L&T has an edge over other players in terms of its pre-qualification in diversified operations and can be expected to gain from corporate capital expenditure.

The company's plans to source and manufacture raw materials and components from China can help boost margins. The China plan can be expected to take off soon with two representative offices already in place.

Rise in input costs and the consequent erosion in margins, especially in the engineering and construction segment, and the risks from increased international projects, are negative factors.

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