(The Hindu Business Line)Investors with a 2-3-year perspective can consider adding the stock of Larsen & Toubro to their portfolio. The company’s proven execution skills, quality clientele, well-entrenched presence in a wide range of businesses and ability to borrow/raise funds at very competitive rates are factors that are likely to ensure a less tumultuous journey for the business during a slowdown, such as the present one.
It is for the above reasons that the stock deserves a premium to other engineering sector peers as well as to the broad markets. At the current market price, L&T trades at 18 times its expected per share earnings (consolidated) for FY10 on a consolidated basis.
L&T’s 70 per cent growth in profits for the quarter ended June 2008 and a massive order book of about Rs 58,000 crore (twice its consolidated sales for FY08) belied fears of earnings taking a hit due to the slowdown in domestic infrastructure and capex spending.
L&T has immensely benefited both from its own superior execution skills and the quality of its clients at a time when the macro scenario carries a fairly high degree of uncertainty. Its superior track record has helped L&T retain its pricing power, with the company managing to protect over 70 per cent of its orders with price escalation clauses.
On the other hand, a roster of frontline clients has ensured that there is no significant slowdown in the company’s capex spending due to funding constraints.
For instance, the active expansion plans of large clients in the metals, minerals, oil and gas and material handling sectors have resulted in huge orders flows for the company. Added to this, presence in regions such as West Asia has also provided the necessary hedge against a domestic slowdown.
While L&T’s current order book is driven by infrastructure and hydrocarbon sectors, the company has made significant progress in adding breadth to its portfolio. Its entry into power equipments, railways and shipbuilding followed by healthy order flows in these new spaces are indicators of this. Any slowdown in the key infrastructure and hydrocarbon sectors is likely to be made up by revenue flows from these new segments especially after 2010.
The company has also managed to raise money at economical rates for all these ventures in a tough interest rate scenario.
A combination of equity expansion and low-cost borrowing has left the company still low on gearing, with no threat of earnings dilution. While lower staff and administrative expenses ensured improved operating profit margins, commodity costs remain a cause for concern. In this regard, L&T’s strategic stake in vendor companies may provide a solution over the long term.
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