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Larsen & Toubro – Hold Citi

December 9, 2008

Citigroup has downgraded Larsen & Toubro from BUY to Hold due to changing macro environment that is likely to affect the best in the Capital Goods class. Adding to L&T’s woes is the availability of capital has reduced and the cost of the same has increased, growth in capital formation is likely to come in at low single digits vs. the 17% CAGR seen during FY03-FY08. Capex cycle is far healthier than the one in the 1990s, incrementally things will only get worse before getting better with the FY10E elections.

Slowdown in Gulf – GCC has gone from excessive credit growth/demand-driven inflation to tight liquidity/concerns over the growth. Falling oil prices have added to the problems. GCC oil & gas/real estate projects are getting delayed/ cancelled.

Without any doubt, L&T is best in class given its strong skill sets/track record/corporate governance. However, order inflow growth could slow to 5% (from 20% earlier) in FY10E. If things don’t improve in the near future by GoI pumping into infrastructure building, L&T may also register a de-growth and prompt the company to bid aggressively on smaller projects thus eroding margins.

Taking the current stress into account, L&T is expected to report a consolidated EPS of Rs 53 for FY09 and Rs 62 for FY10. Citi values the L&T business at a mere 14 forward P/E and values it at Rs 683, while the subsidiaries including L&T Infotech are valued at Rs 105 thus setting a target of Rs 788 with a HOLD recommendation.

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