Larsen & Toubro Ltd. – A winner till date, but is it efficient?

Larsen & Toubro’s 10 YEAR X-RAY: Green (Very Good)

Larsen & Toubro, in brief

Larsen & Toubro Ltd, is a name known to most people. It is one of India’s leading engineering and construction company. Let’s see what is its business and how it operates:

Revenue Segregation: Its business operations are categorized in three segments, as given below

a) Its Engineering & Construction (E & C) segment that is further divided into 4 operating divisions:

b) Its Electrical & Electronics Segment:

c) Its Material Handling & Industrial Products:

Industries it Caters to: Caters to verticals of Infrastructure (33%), Power (30%), Hydrocarbon (15%), Process Automation (16%) and others

Clientele: Largely a domestic player with a mix of public and private sector companies like ONGC, Reliance (RIL), Indian Oil, GSPC, NHAI, Tata Steel, NTPC, etc.

What does Larsen & Toubro’s past say?

L & T has performed robustly in all its parameters over the last 10 years. Its impressive fundamentals in the past form a strong base for its future.

L&T has clocked an impressive CAGR of 67% in its EPS which has been possible due to the strong investment back into the business which is evident from its high BVPS CAGR of almost 50%. Also, it has improved its margins over the years from a stagnant average of 10-11% from FY 03 to FY 06 to 15% in the last 4 years. In fact in 2010 the company’s operating margin has increased to 19%.

It’s Sales have registered a CAGR of 19.6% over the last 10 years, indicating a good order inflow over the years. Over the past 5 years the CAGR of order inflows has been 33%. This has helped the company register an impressive 67.2% CAGR over the last 10 years.

Hence, the 10 YEAR X-RAY of L&T is Green (Very Good)

What is L & T’s short-term outlook?

How did L&T perform in the June quarter?

L & T registered a single-digit top line growth, but a fall in profits mainly due to:

• Subdued performance from its E & C segment, which grew  marginally by 1% because many projects bagged in the second half of last year were at the initial stage of design/ engineering.

• A higher interest and depreciation cost led to a fall in profits

Looking forward (FY11), what is in store for the company?

Healthy Order-Book :

The company has been witnessing an increase in order inflows since the past few months. Order inflow for the quarter ended June 2010 was Rs. 15626 Cr., up 63% on y-o-y basis. The company expects increased bidding activities in the next few months and expect this momentum to continue. As of June’10 the company has a healthy order book of Rs. 100239 Cr. to be completed over the next 2-3 years. Recently (24th Aug), the company bagged 2 projects worth Rs. 1200 Cr. from ONGC to set up additional processing units at its plants Hence, this is expected to ensure good revenue growth in the coming quarters.

Capacity Expansion Plans:

The company is planning capacity expansions for the year FY11 in order to take advantage of the demand in future. Few of these are:

• Improvement at their Hazira & Coimbatore manufacturing facilities to improve on execution time
• A new manufacturing facility at Baroda for catering to electrical products market.
• New Shipyard at Tamil Nadu for large defense ships

The company has indicated an approx cost of Rs.2000 Cr. for these plans. Where all of these are expected to cater to future demand and facilitate growth, it also means increased costs.

But, what should you (as an investor) be concerned about?

Order Loss:

Recently L & T was disqualified from being a bidder for NTPC’s order of Rs. 25,000 Cr. to supply supercritical powers. L  & T was found ineligible on technical parameters. This is a big loss for L & T as it was one of the only 2 bidders and has lost out on a big order.

Where, the company has given a good indication of sales growth for FY11, healthy order book and lower raw material costs, it has been facing order execution problems since few months, now. Also the above order-loss is a cause for concern.

Hence, looking at the above the short-term future prospects of the company are Orange (Somewhat Good).

What is L & T’s long-term outlook?

Let’s see the factors that are expected to drive future growth?

1) Power, Infrastructure to drive order-growth:

L & T receives around 35% orders from Infrastructure and 30% from Power. Both these sectors are well-poised for growth in the future due to the government’s emphasis on infrastructure and power development.

A combination of higher government spending & Public Private partnerships is expected to drive new investments. Also segments like Transport & Railways have received additional funding of 23% and 45% from the government, giving these sectors a boost too.

The company already has a healthy order book of Rs. 100239 Cr. (next 2-3 years) out of which more than 60% is from Infrastructure & power.

Hence, these industries are expected to drive orders for the company and the company is well-placed to execute big orders in the above segments.

2) Structure of the Engineering industry:

L & T is one of the largest heavy engineering companies in India and the inbuilt structure of this industry affects its growth:

• The engineering industry is highly dependent on the fluctuations of input costs like steel and aluminum where an increase in their prices affects the inflow of orders as companies spending on new projects reduces.
• The Major User Industries are power & infrastructure, where power contributes around 60% to revenues.
• The engineering industry has clocked an approx 27% CAGR for its Net Sales and an impressive 24% CAGR for profits over the last 6 years* and is expected to grow by over 20% in the next 5- 6 years. *(Based on calculation of the BSE 500 companies in the engineering industry).
• Since the industry is capital intensive and requires a high level of technical expertise, the high entry barrier makes it very dif¬ficult for other players to eat into the market share of existing players here.
  
• Major players(BHEL & L&T)- BHEL is India’s largest power equipment manufacturer with the highest market share. But, lately BHEL’s market share has been falling and has reduced from 70% earlier to almost 55-60% right now. L & T is in the 2nd place in the same segment.

To know more on the Indian Engineering Industry and how it functions, become a member of www.MoneyWorks4me.com and read the wiki report on Engineering

3) Clear Organization of business well-aligned with future growth:

The company operates its business through 8 divisions, each headed by a separate director. All its divisions have a clear pathway for the future which has been clearly mentioned in their annual report. Each of these divisions have created operating companies that further help to organize functions and work towards clearer goals.. Also, the company has chalked out major expansion plans to draw on future opportunities; L & T has taken proactive steps in setting up manufacturing capacities ahead of demand triggers. (Mentioned in short-term). This will help the company further strengthen its position in the engineering industry.

So, seeing the above, L&Ts future seems bright, but it depends on how efficiently it runs its operations, which seems to be a cause for concern. Let’s see what you should be concerned about:

Curious Case of 4th quarter reporting:

Over the last few years, the company has always been reporting a sudden jump in its 4th quarter sales & earnings. Consider FY 10 when in the first 3 quarters company has reported an average sales of Rs. 8000 and profits of 650 Cr. Suddenly in the 4 th quarter it reported sales of more than Rs. 13000 Cr and profit of more than 1300 Cr. This creates concerns about either its operating efficiencies in the first 3 quarters or it 4th quarter reporting.

High Outstandings:

Since the last few years, L & T has had a huge amount of cash locked up in its debtors(outstanding) cycle. As of FY10, the company has Rs. 11163 Cr. locked in outstandings on a sales turnover of Rs. 37000 Cr. which works out to a debtors cycle of 109 days. Also, the outstanding for more than six months is very high at Rs. 3163 Cr. which amounts to 28% of its total outstanding. For a company earning a net profit of Rs. 3315 Cr. such a high outstanding; especially the more than 6 months figure creates major cause for concern. Hence, in the wake of the first point, this high outstanding become a further reason to worry.

High Payables:

The company has a ROIC average of 18% over the last 6 years. This has been generated at the cost of its creditors. Its creditors(payables) is very high at Rs. 19054 Cr. on a cost of goods of approximately of Rs. 27000 Cr which works out to 250 days. This indicates that the company is almost operating at the cost of its suppliers. The benefit of getting such high credit periods, usually comes with significant costs attached. 

This is not just an L&T problem, other players in the industry too have such operational inefficiencies. But, when industry leaders like L&T also follow such ways of functioning, it becomes almost like an industry practice.

Such operational inefficiencies tends to further hide many more inefficiencies. For eg: The company may be facing execution issues or even quality problems which can be a probable reason for high debtors.

Hence, to remain a winner in future L&T has to make sure it improves on these inefficiencies. This is crucial for its future success.

L&T is one of the largest engineering companies in India & has the strength to exploit future opportunities in sectors like Power, Infrastructure etc. Hence, the long-term future prospects of the company are Green (Very Good), provided it improves on its above mentioned inefficiencies.

Conclusion

L & T is one of the leading players in the Indian Engineering Industry. It is poised for good growth in future considering the government focus and spending on Infrastructure & power, its strategic plans and capacity expansions. But it needs to work on a plan to manage its operating inefficiencies.

Yes, L & T is an investment-worthy company, but is it at a good price to buy? Or is the market overvaluing it? To find out what investment decision you must take on L&T right now, become a member of www.MoneyWorks4me.com to find its right value.

If you liked what you read and would like to put it in to practice Register at MoneyWorks4me.com. You will get amazing FREE features that will enable you to invest in Stocks and Mutual Funds the right way.

---