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PLEASE SEE IMPORTANT DISCLOSURES INCLUDING FOREIGN AFFILIATE DISCLOSURES BEGINNING ON PAGE 64
ASIALarsen & ToubroProxy to India Investment Theme
Larsen & Toubro (L&T) is among the largest E&C companies in India today. L&Thas expertise in design, engineering and construction across various industries,
including oil & gas, petrochemicals, refineries fertilizers, metals and power. It is
one of the largest players in the domestic infrastructure sector and has a presence
across all segments, namely, roads, ports, urban infrastructure and airports.
Massive capex programmes, coupled with the governments renewed thrust oninfrastructure development, indicate a huge opportunity for engineering &construction (E&C) companies. L&T, which is one of the leading E&C firms inIndia, is a strong play on this boom. With increasing size and complexity ofprojects, L&T has a distinct advantage over its peers, given its stronger technicaland financial strengths, in our view.
There is strong earnings visibility as we expect the order book to continue to growat 31% p.a. over FY07-10. We expect to see marginal improvement in marginsas well. Key L&T subsidiaries are expected to record earnings growth in excess of30% p.a. over the next three years. We expect further value to emerge from somesubsidiaries over the next three years.
The company is undertaking further initiatives to capitalize on certain opportunitiesthat should help sustain growth and profitability over a longer period of time.Some of these include investments in power equipment manufacturing,shipbuilding, defence equipment manufacturing, and investments in the MiddleEast and infrastructure as a developer.
Key risks to our growth assumptions include an economic slowdown and politicaluncertainty adversely impacting policy initiatives, particularly in the infrastructurespace.
FY06 FY07 FY08E FY09E FY10E
Revenues (INR mn) 147,640 176,142 225,309 301,512 413,514Core EBITDA (INR mn) 10,667 17,786 24,658 33,431 46,865EBITDA (INR mn) 15,013 22,055 30,214 39,189 53,095PAT (INR mn) 10,186 14,030 18,551 23,646 32,167Shareholders funds (INR mn) 46,402 57,684 74,647 92,486 118,845Core EBITDA margins (%) 7.2 10.1 10.9 11.1 11.3EBITDA margins (%) 10.2 12.5 13.4 13.0 12.8Net margins (%) 6.43 7.97 8.23 7.84 7.78
RoE (%) 21.4 30.8 35.2 39.0 41.6Source: Lehman Brothers estimates
BASIC INDUSTRIES
India Infrastructure &Construction
Ticker: LART.NSPrice (11 Oct 07): 3486.65
Exchange: BSESENSEX: 18,814
Saion Mukherjee91.22.4037.4184
[email protected], India
Tanuj Shori91.22.4037.4028
[email protected], India
Analyst Certification
We, Saion Mukherjee and TanujShori, hereby certify (1) that theviews expressed in this research
report accurately reflect ourpersonal views about any or all
of the subject securities or issuersreferred to in this report and (2)
that no part of our compensationwas, is or will be directly or
indirectly related to the specificrecommendations or views
contained in this report.
October 16, 2007
http://www.lehman.com
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2 October 16, 2007
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THIS DOCUMENT DOES NOT CONSTITUTE AN OFFER OR INVITATION OR FORM PART OF AN OFFER OR INVITATION
TO SUBSCRIBE FOR OR PURCHASE ANY SECURITIES, AND NEITHER THIS DOCUMENT NOR ANYTHING CONTAINED
HEREIN SHALL FORM THE BASIS OF ANY CONTRACT OR COMMITMENT WHATSOEVER.
This report has been prepared by Saion Mukherjee and Tanuj Shori, employees of Lehman Brothers Securities Private Limited,
to provide background information about Larsen & Toubro Limited (the Company). Lehman Brothers Securities Private Limited
or an affiliated company of Lehman Brothers Securities Private Limited (collectively, Lehman Brothers) is or may be a member
of the underwriting group in respect of a proposed offering of securities of the Company. This report has been producedindependently of the Company and the forecasts, opinions and expectations contained herein are entirely those of Lehman
Brothers. While all reasonable care has been taken to ensure that the facts stated herein are accurate and that the forecasts,
opinions and expectations contained herein are fair and reasonable, neither Saion Mukherjee and Tanuj Shori nor Lehman
Brothers have verified the contents hereof and, accordingly, neither Lehman Brothers, the Company, nor any of their
respective directors, officers or employees, shall be in any way responsible for the contents hereof, and no reliance should be
placed on the accuracy, fairness or completeness of the information contained in this document. No person accepts any
liability whatsoever for any loss howsoever arising from any use of this document or its contents or otherwise arising in
connection therewith. Lehman Brothers and/or persons connected with it may have acted upon or used the information herein
contained, or the research or analysis on which it is based, before its publication. Lehman Brothers may in the future
participate in an offering of the Companys securities. Any opinions, forecasts or estimates herein constitute a judgement as at
the date of this report. There can be no assurance that future results or events will be consistent with any such opinions,forecasts or estimates. This information is subject to change without notice and its accuracy is not guaranteed. It may be
incomplete or condensed and it may not contain all material information concerning the Company. Any decision to purchase
securities in any offering of the Companys securities should be made solely on the basis of the information to be contained in
the final offering circular to be published in due course in relation to such offering.
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October 16, 2007 3
Valuation disclosure
The projections, expectations, forecasts and valuations described in this report were
based upon a number of estimates and assumptions and are inherently subject to
significant uncertainties and contingencies. Projections, expectations, forecasts and
valuations are necessarily speculative in nature, and it can be expected that one or more
of the estimates on which the projections, expectations, forecasts and valuations werebased, as the case may be, will not materialize or will vary significantly from actual
results, and such variances will likely increase over time. All projections, expectations,
forecasts and valuations described in this report have been prepared solely by the
authors of this report independently of the Company. These projections, expectations,
forecasts and valuations were not prepared with a view toward compliance with
published guidelines or generally accepted accounting principles. No independent
accountants have expressed an opinion or any other form of assurance on these
projections, expectations, forecasts and valuations. You should not regard the inclusion
of the projections, expectations, forecasts and valuations described herein as a
representation or warranty by or on behalf of the Company, Lehman Brothers, the authorsof this report or any other person that these projections, expectations, forecasts and
valuations or their underlying assumptions will be achieved. For these reasons, you
should only consider the projections, expectations, forecasts and valuations described in
this report after carefully evaluating all of the information in this report, including the
assumptions underlying such projections, expectations, forecasts and valuations.
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4 October 16, 2007
Table of Contents
Investment argument .........................................................................................5Investment risks ................................................................................................8Valuation...................................................................................................... 10Financial statements........................................................................................16Financial outlook............................................................................................18Company background....................................................................................24The road ahead ............................................................................................ 42Industry outlook Set for an inflection ................................................................48Indian construction industry ..............................................................................58
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October 16, 2007 5
Investment argument
A strong play on Indias capex and infrastructure investment story
Corporate Indias capacity utilization is at a 15-year high, debt-equity ratio is near an all-
time low, and the capex-profit ratio has just begun to rise. Massive capex programmes,
coupled with the governments renewed thrust on infrastructure development, indicate a
huge opportunity for engineering & construction (E&C) companies. We expect industrial
capex over next five years to be 2.6x the investment in the past five years. Similarly in
the infrastructure space, investments in the Indian governments XI plan period (FY08-12)
are expected to be around 2.45x the investment in the X plan (FY03-07). L&T, which is
Indias premier E&C firm, is a strong play on this boom. L&T has a dominant position in
the oil and gas and metal space with a market share in excess of 30%. Both of these
segments are expected to witness strong growth in capex. Similarly in the infrastructure
space, L&T holds leadership positions in airports and power. The size and complexity of
the projects are increasing. For instance, for road projects, the average order size can
be as large as 100 km compared to 15-20 km two years ago. L&T is much larger
compared to most of its peers and possesses the technical and financial strength toaddress the opportunity, in our view.
Figure 1: Average industrial capex inflection over the next five years
Source: Capital-line, Lehman Brothers estimates
148 224
1,785
253350600
4,004
1,416
0500
1,0001,5002,000
2,5003,0003,5004,0004,500
Automobiles and Auto Cements Oil/gas Metals
(INR bn)
Capex over last 5 years 2002-07 Capex over next 5 years 2007-12
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Figure 2: Inflection in infrastructure spending
(INR bn)
13,500 14,400 15,50016,900 18,000
24,700
32,20038,400
46,600
57,300
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
FY03 FY04 FY 05 FY06 FY07 FY08 FY 09 FY10 FY11 FY12
Note: The above numbers include storage and city gas distribution. In our discussion on infrastructure weexclude storage and gas distribution. In any case it forms just 2% of the investment.Source: Planning commission documents, Lehman Brothers estimates
Expect growth momentum to continue
L&Ts order book has shown robust growth even off a large base. We expect the order
book to continue to record a CAGR of 31% over FY07-10. We expect L&T to capture a
significant market share of the projected domestic industrial capex. Competition is much
stiffer in the infrastructure sector among the existing players, but given L&Ts proven
execution capabilities and size to capture bigger projects, we believe that it will capture
a decent share in the infrastructure segment as well. The complexity of projects is rising
and hence we believe that L&T with the requisite financial and technical expertise is at
an advantage. We project a revenue CAGR of 34% over FY07-10.
Margins have recorded improvements across all business segments in FY07. The netmargins improved 106 bps to 7.96% in FY07. The improvement was driven by
operational efficiencies, improved margins in new projects and operating leverage. We
expect to see marginal improvement in margins as well. We expect L&T to deliver 34%
growth in EBITDA over FY07-10.
Strong up-tick in subsidiary financials
Subsidiary financials registered a steep improvement in FY07. Subsidiaries contributed
53% of consolidated profits in FY07 and recorded growth of 176% over the previous
year. The key contributors were L&T Infotech, L&T-IDPL (equity dilution of IDPL stake and
sale of operating BOT (build, operate, transfer) projects) and manufacturing subsidiaries.We expect L&T Infotech, L&T Finance and certain manufacturing subsidiaries to record
growth in excess of 30% over the next three years. Value discovery in some of the
subsidiaries is a strong possibility over the next three years. The initial public offering
(IPO) of L&T Infotech is expected in 2008, according to the company.
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October 16, 2007 7
Enough reinvestment options-
L&T is creating various opportunities for re-investing cash flows. According to the
company, as a long-term strategy, L&T will invest in scalable businesses where it can
leverage its strength in E&C. The focus will be on maximizing value creation and
avoiding commoditization. Going forward, the bias is towards design, engineering and
manufacturing rather than plain vanilla construction. L&T has planned investments tocapture potential opportunities in power equipment, shipbuilding, defence and the
Middle East investment boom. These initiatives should start contributing to the financials
from FY10 onwards and deliver returns in excess of the cost of equity, in our view.
We expect L&T to invest equity in infrastructure projects where it will participate as a
developer. We appreciate the potential risks involved in such projects, such as execution
risks etc. However, given L&Ts strong execution capabilities and prudence in selection of
projects, overall, we expect the portfolio of projects to deliver returns in excess of the cost
of equity.
We expect strong earnings growth over FY07-10
We expect earnings growth to remain strong. We project an earnings CAGR of 32%
over FY07-10 and RoE of 35% in FY08 (adjusted for investments in subsidiaries). We
believe the earnings growth is sustainable as order inflows are expected to remain strong
and there are possibilities of upside to margins.
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Investment risks
Macro risks
L&T is leveraged to investment in industrial capex and infrastructure in India. Any
delay in investments would present a significant risk to earnings and stock
performance.
Political instability or changes in the government resulting in significant changes in
policy initiatives would present risk to the infrastructure sector in particular. This could
delay the award activity in infrastructure projects.
The equity returns particularly for infrastructure projects under the Public Private
Partnership (PPP) are sensitive to interest rates. A hardening of interest rates would be
a negative.
L&T Infotech, which is mainly dependent on US sales, could be adversely impacted
by any appreciation of the rupee against the US dollar.
Cement and steel are two key raw materials used in construction. Any significant rise
in cost could impact near-term earnings adversely.
Company-specific risks
Robust growth in order book and execution for the same will become a key factor
for the companys performance. An inability to conclude a project on time could
impact its earnings adversely.
Managing growth may come under stress in case the company fails to attract and
retain talent. Given strong growth in construction and the capital goods industry,
there is a shortage of talented manpower in the industry.
The company plans to invest equity in new ventures and we have factored in
potential upside from these investments. Some of the investments of importance are
power equipment manufacturing, shipbuilding and BOT infrastructure projects. Any
delay in execution would impact potential value discovery adversely.
Regulatory risks
We have assumed a benign regulatory environment as far regulations for investment
in infrastructure are concerned. The Indian government has taken policy initiatives to
attract private investment into infrastructure. Any significant policy changes could,
therefore, present risk to our optimistic assumptions.
Oil and gas, metals and power are the key sectors for L&T. Any adverse regulatory
changes in these sectors could present a risk.
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October 16, 2007 9
Competition
We have assumed that L&T will continue to post robust growth even off a large base and
that the company can continue to maintain market share in the segments in which it
operates. Our assumptions are based on L&Ts stronger technological, execution and
financial strengths. Aggressive competition from local or foreign players could impact
these growth assumptions adversely.
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Valuation
We have valued L&T using the sum-of-the-parts (SOTP) methodology. Core E&C business
(L&T standalone) is based on the dividend discount model (DDM) methodology. One-
year forward value of the E&C business is between INR718 bn and INR1,010 bn. To
this value, we have also added values for L&T Infotech, L&T Finance, Capital and
Infrastructure Finance, L&T IDPL, the housing company for L&Ts BOT projects, L&Ts ECCand EC&Ps subsidiaries and associates, manufacturing associates, foreign subsidiaries,
as well as value for L&Ts holding in Ultratech Cement. Hence, our target valuation range
is between INR924 bn and INR1,292 bn.
Figure 3: Sum-of-the-parts valuation
BusinessBest-case scenario(INR bn) Base case scenario(INR bn)
Core E&C business 1010 718SubsidiariesL&T Infotech 53 47
L&T Finance+ Infrastructure Finance+ Capital 53 38
L&T IDPL 81 27
Engineering construction & project subsidiaries and
associates
14 11
Manufacturing associates 34 31
Foreign subsidiaries 28 24
Ultratech Holding 18 18One-year target valuation (September 2008) 1292 924US$ bn 32 23Source: : Lehman Brother estimates
E&C business valued between INR 718 bn and INR 1,010 bn
We value the base E&C business based on a dividend discount model. The key
assumptions of the model are:
Explicit earnings and RoE projections until FY10
Earnings are adjusted for the dividend income from the subsidiaries
30% adjusted earnings growth from FY11-13
Post FY13, the adjusted earnings gradually drop to terminal growth by FY17
Terminal growth at 5% and 6% after FY17 for the base and best case respectively
RoE drops to 30% by FY17 and maintained thereafter
Discount rate of 12% for the base-case and 11% for the best-case scenario.
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With the above assumptions we arrive at our one-year forward fair value range of
INR718 bn INR1010 bn. Our one-year forward fair value range represents an
earnings multiple range of 26.3x 36.9x one-year forward earnings after adjusting for
the dividend income from subsidiaries.
The valuation range of the subsidiaries is estimated at INR196-287 bn as detailedbelow. If we were to adjust for the valuations of the subsidiaries using this range, L&T
base business is then currently trading at a forward earnings multiple of 34.9-39.1x.
Dividend discount model
Valuation of L&T IDPL
Best-case analysis
L&T IDPL is the holding company for all of L&Ts BOT projects (except in the power
sector), and L&T plans to pursue all BOT projects through IDPL. L&T holds a 78.4% stake
in L&T-IDPL. We value L&T IDPL using a sum-of-the-parts methodology:
Disclosed infrastructure projects
L&T- Urban infrastructure Ltd (L&T-UIL) which is a subsidiary of L&T-IDPL. L&T IDPL holds
75% in L&T-UIL
Growth value of future investments
Figure 4: Valuing disclosed infrastructure projects
Projects Holding Equity value(INR m) one-year forward CommentsL&T transportation infrastructure Ltd 1 2642 This is an operational road project. Valued on DCF. Discount rate of
10% used. Valuation implies P/B of 6x.Narmada Infrastructure Construction
Enterprises Ltd
1 1761 This is an operational road project. Valued on DCF. Discount rate of
10% used. Valuation implies P/B of 3.5x.
Kakinada Seaports 0.39 2072 This is a very profitable operational port project. Valued on DCF.
Discount rate of 10% used. Valuation implies P/B of 15.6x.
Western India Tollbridge Ltd 1 380 This is an operational road project. Valued on DCF. Discount rate of
10% used. Added cash on books. Valuation implies P/B of 2.6x.
Second Vivekananda bridge tollway 0.33 869 Just operationalised BOT. Valuation based on 1.7x equity invested.
International seaports Haldia Pte Ltd 0.22 390 Based on 7x equity
L&T panipat elevated corridor 1 927 Under implementation. Assumed 18% equity IRR.
L&T Krishnagiri Thopar tollroad 1 1006 Under implementation. Assumed 18% equity IRR.
L&T Vadodara Bharuch 1 2240 Under implementation. Assumed 18% equity IRR.
L&T Western Andhra tollways 1 644 Under implementation. Assumed 18% equity IRR.
L&T interstate road corridor 1 862 Under implementation. Assumed 18% equity IRR.
Dhamra ports company 0.5 176 Under implementation. Assumed 20% equity IRR.
Bangalore International Airport 0.17 366 Under implementation. Assumed 25% equity IRR.Total 14335Source: Company, Lehman Brothers estimates
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As of March 2007 L&T-IDPL has already invested INR 5.05 bn in various infrastructure
projects. Therefore the valuation implies a multiple of 2.4x equity invested.
Valuing L&T-UIL
L&T IDPL holds a 75% stake in UIL with 25% being held by HDFC which was brought in
as a strategic investor in the business. L&T IDPL and HDFC have invested INR5,720 mnas equity in L&T UIL (FY07). We have valued L&T-UIL business at 1.83x book assuming
RoE of 22% from the venture. The March 2007 value of L&T-UIL is INR10.5 bn. L&Ts
share in IDPL is valued at INR7,309 mn (one-year forward value).
In FY07, HDFC infused INR950 mn for a 25% stake in the L&T-UIL. This values L&T-UIL at
INR3,800 mn. We understand HDFC came in as a strategic partner and there has been
significant growth in the portfolio since the entry of HDFC. Therefore HDFCs funding is
not the correct valuation benchmark, in our view.
Valuing growth
Management has guided that it will invest around INR4-5 bn as equity in each of the
coming few years in L&T IDPL. To value the growth potential we assume that L&Ts
investment shall grow in line with the investment in infrastructure in the economy. Our key
assumptions are:
Currently L&Ts annual investment in IDPL is 0.16% of the Gross Capital Formation in
Infrastructure (GCFI). We assume this ratio to continue
Nominal GDP growth of 13.2%, 14.5% and 14.5% in FY08, FY09 and FY10
respectively. Nominal GDP growth of 13% from FY11-17. 8% Nominal growth is
assumed until FY20 and thereafter 5%.
GCFI is expected to increase gradually from 5% currently to 10% by FY20. Terminal
year GCFI assumed at 3%.
18% equity return generated from these investments.
Terminal growth rate of 3% and discount rate of 12%.
This gives us a one-year forward value of INR62,063 mn.
As per the recent consultation paper from the planning commission, the private investment
in infrastructure other than power is estimated at INR1940 bn over the next three years.
Assuming a debt:equity of 80:20, equity investment shall be INR388 bn. L&T IDPLs
equity investment of INR15 bn (INR5 bn every year in infrastructure other than power
over next three years) over next three years represents a market share of only 3.9%.
Therefore, we believe that investments planned by L&T-IDPL in the infrastructure projects
can go up with more opportunities coming up.
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Figure 5: Figure: Valuation of L&T-IDPL
L&T-IDPL value (INR mn) L&T value (INR mn)Existing infrastructure projects 14,335 11,239
L&T-UIL 9,322 7,309
Growth value 79,162 62,063Total 102,820 80,611Source: Company, Lehman Brothers estimates
Assuming an investment of INR 9 bn over the next two years our valuation implies a P/B
to 4.9x FY09 book.
Base-case analysis
For the base case we have valued L&T IDPL on the basis of stake sale to IDFC and JP
Morgan. IDFC picked up 21.6% stake of IDPL for INR5,500 mn in April, 2006. This
would value L&Ts stake in L&T IDPL at INR1,9963 mn. Rolling forward this value for
2.5 years at 12% cost of equity, we arrive at one-year forward value of INR26,501 mn.
We have taken this as the base valuation figure for L&T IDPL.
L&T Infotech valued between INR47 bn and INR53 bn
We have valued L&T Infotech between INR47 bn and INR53 bn. Our valuation range is
based on the multiple imputed on FY09 earnings. We have imputed a multiple of 14x
and 16x for the base and best case respectively to arrive at a March 2008 value. We
then rolled forward the value for six months at a 12% cost of equity to arrive at a one-
year forward value. The company is expected to record earnings growth of 40% and an
RoE of 40%.
L&T Finance and Infrastructure Finance valued between INR38 bn and INR53 bn
We have valued L&T Finance and Infrastructure finance between 2.5x and 3.5x FY09E
book value to arrive at a March 2008 value and then rolled it forward at a 12% cost of
equity to arrive at a one-year valuation range. L&T finance has a RoE of 17% and is
expected to grow in excess of 50% over the next three years.
Engineering and construction subsidiaries and associates valued between INR11 bnand INR14 bn
We have valued L&T-Ramboll, Voith Paper, HPL CoGen, India Infrastructure Developers,
L&T Sargent and Lundy Ltd, L&T Chiyoda and L&T Valdel. The entities are valued at times
earnings or book and are appropriately rolled forward.
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Figure 6: Engineering and construction subsidiaries
L&T Holding L&Ts Value in INR m (one-year forward) CommentsL&T Ramboll Consulting Engineers Ltd 50% 982 1,178 25-30x FY09. Expected to grow by 50%-80%
over the next 3 years
Voith Papers Technology Ltd 50% 3,006 3,606 25-30x FY09. Expected to grow by 50%-
100% over the next 3 years
International Seaport Dredging Limited 61% 629 838 25-30x FY09. Expected to grow by 20%-25%over the next 3 years
HPL Cogeneration 51% 4,080 4,663 The plant valued at a RoE range of 35%-40%.
India Infrastructure developers 100% 719 1079 Valued at 1x 1.5x FY07 book
L&T Sargent & Lundy Ltd 51% 219 233 15x 16x FY09 EPS
L&T Chiyoda 50% 1,156 1,387 25x 30x FY07 profit
L&T Valdel 50% 603 -724 25x - 30x FY07 profit
Total 11,393 13,708
Source: Company, Lehman Brothers estimates
Manufacturing associates valued between INR 30 bn and INR34 bn
The entities valued are: Audco India, L&T Komatsu, L&T Case, EWAC alloy, L&T Demag,Tractors Engineers Ltd. The entities are valued at times earnings and are appropriately
rolled forward.
Figure 7: Manufacturing associates
Holding L&Ts Value in INR m (one-year forward) CommentsAudco India limited 50% 6,444 7,581 17x20x FY09 earnings. Expected to grow in at 17% over the next 3
years
L& Komatsu 50% 12,052 13,257 20x-22x FY09 earnings. Expected to grow in excess of 30% over the
next 3 years
L&T case Equipment 50% 3,855 4,240 20x-22x FY09 earnings. Expected to grow in excess of 30% over the
next 3 years
EWAC alloys Ltd 50% 3,449 3,794 20x-22x FY09 earnings. Expected to grow in at 20% over the next 3years
L&T-Demag Plastics 50% 494 - 543 20x-22x FY09 earnings. Expected to grow in at 20% over the next 3
years
Tractors Engineers Ltd 100% 4,339 4,772 20x-22x FY09 earnings. Expected to grow in at 20% over the next 3
yearsTotal 30,632 34,187Source: Company, Lehman Brothers estimates
Foreign subsidiaries valued between INR24 bn and INR28 bn
The entities valued are: L&T International FZE, L&T Oman, L&T Qatar, L&T Electromech,
L&T Saudi. The entities are valued at times earnings and are appropriately rolledforward.
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Figure 8: Foreign Subsidiaries
L&THolding L&Ts Value in INR m (one-year forward) CommentsL&T Oman LLC 65% 6,904 7,594 20x-22x FY09 earnings. Expected to grow at 25-30% over the next 3
years
L&T International FZE 100% 10,632 13,290 8x-10x FY09 earnings. Gains mainly from hedging activities. No
significant growth expected.L&T Qatar LLC 49% 828 20x FY09 earnings. Expected to grow in at 25-30% over the next 3
years
L&T Electromech 65% 5,394 5,934 20x-22x FY09 earnings. Expected to grow in excess of 30% over the
next 3 years
L&T Saudi LLC 95% 454 10x FY09 earnings. Growth muted. Not much visibility.
Total 24,213 28,100
Source: Company, Lehman Brothers estimates
Holding in Ultratech Cement: INR18 bnL&T holds 14.3 mn shares of Ultratech Cement (11.4% of the company). The lock-in
period for these shares ended in June 2007, but the company has not sold off its stake,
though it has indicated that it might not be interested in a long-term holding of this stake.
The valuation is based on the current price.
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Financial statements
Standalone P&L Statement
Figure 9: Income Statement
Year-end 31 Mar (INR mn) FY06 FY07 FY08E FY09E FY10ENet sales 147,640 176,142 225,309 301,512 413,514
Operating expenses -136,973 -158,356 -200,651 -268,081 -366,649
Manufacturing, construction & operating expenses -115,603 -130,782 -166,162 -222,360 -304,960
Staff expenses -8,925 -12,582 -15,788 -20,695 -27,367
Sales, administration & other expenses -12,444 -14,992 -18,701 -25,025 -34,322Core EBITDA 10,667 17,786 24,658 33,431 46,865Other income 4,346 4,270 5,556 5,758 6,229EBITDA 15,013 22,055 30,214 39,189 53,095Interest -751 -339 -720 -1,244 -1,520
Depreciation & amortization -1,160 -1,715 -2,214 -2,914 -3,564
Company's shares in Profits of JVs 64 0 0 0 0
Overheads charged to fixed assets 19 33 0 0 0
Transfer from revaluation reserve 15 14 0 0 0
Pre tax profit 13,201 20,049 27,280 35,031 48,011
Provision for taxation -3,713 -6,019 -8,730 -11,385 -15,844
PAT before extraordinary items 9,488 14,030 18,551 23,646 32,167
Extraordinary items 698 0 0 0 0Net profit 10,186 14,030 18,551 23,646 32,167Source: Company data, Lehman Brothers estimates
Note: core EBITDA figures are analyst estimates
Standalone balance sheet
Figure 10: Balance SheetYear-end 31 Mar (INR mn) FY06 FY07 FY08E FY09E FY10ECurrent assets 95,365 118,847 146,366 194,192 263,432
Investments 19,195 31,044 41,044 51,044 61,044
Net fixed assets 16,046 22,247 32,533 42,120 49,556
Other non-current assets 1,545 1,745 1,745 1,745 1,745Total assets 132,152 173,883 221,689 289,102 375,778Current liabilities & provision 69,116 93,373 120,436 159,790 216,106
Total debt 14,536 20,778 24,558 34,778 38,778
Other liabilities 2,098 2,049 2,049 2,049 2,049Total liabilities 85,750 116,199 147,042 196,616 256,933Share capital 275 567 574 574 574
Reserves & surplus 26,014 35,575 48,318 66,156 92,516
Other funds 20,113 21,543 25,756 25,756 25,756Shareholders' funds 46,402 57,684 74,647 92,486 118,845Total equity & liabilities 132,152 173,883 221,689 289,102 375,778
Source: Company data, Lehman Brothers estimates
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Standalone cash flow statement
Figure 11: Cash Flow Statement
Year-end 31 Mar (INR mn) FY06 FY07 FY08E FY09E FY10EPre-tax profit 11,757 20,035 27,280 35,031 48,011
Depreciation 1,145 1,715 2,214 2,914 3,564
Total tax paid -3,297 -6,275 -8,730 -11,385 -15,844Chg in working capital 4,087 5,887 -4,494 -7,724 -12,879
Other operating activities 179 0 0 0 0Cash flow from operations (a) 13,693 21,361 16,270 18,835 22,852Capital expenditure -5,816 -6,999 -12,500 -12,500 -11,000
Chg in investments -7,447 -11,849 -10,000 -10,000 -10,000
Other investing activities 0 0 0 0 0Cash flow from investing (b) -13,263 -18,848 -22,500 -22,500 -21,000Free cash flow (a+b) 429 2,513 -6,230 -3,665 1,852
Equity raised/(repaid) 103 165 4,220 0 0
Debt raised/(repaid) 931 6,242 3,780 10,220 4,000
Dividend (incl. tax) -3,912 -5,736 -5,808 -5,808 -5,808
Other financing activities 0 0 0 0 0
Cash flow from financing (c) -2,878 671 2,192 4,412 -1,808Net chg in cash (a+b+c) -2,448 3,184 -4,037 748 45
Source: Company data, Lehman Brothers estimates
Standalone key ratios
Figure 12: Key ratios
Year-end 31 Mar FY06 FY07 FY08E FY09E FY10EGrowth (%)Revenue growth 12.0 19.3 27.9 33.8 37.1
Expenses growth 10.7 15.6 26.7 33.6 36.8
Core EBITDA growth 31.4 66.7 38.6 35.6 40.2EBITDA growth 44.1 46.9 37.0 29.7 35.5
Net profit growth 3.7 37.7 32.2 27.5 36.0Margins (%)Core EBITDA margin 7.2 10.1 10.9 11.1 11.3
EBITDA margin 10.2 12.5 13.4 13.0 12.8
Pre-tax margin 8.9 11.4 12.1 11.6 11.6
Net margin 6.43 7.97 8.23 7.84 7.78Profitability (%)ROE 21.4 30.8 35.2 39.0 41.6
ROCE 15.8 17.7 18.8 18.9 20.8
Source: Lehman Brothers estimates
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Financial outlook
L&T Standalone
Revenue CAGR of 33% and order inflow CAGR of 31% over FY07-FY10E
We expect L&Ts standalone gross revenues to grow at an annualised rate of 33% over
FY07-FY10. This growth is expected to be driven primarily by the E&C segment, in
which we expect a revenue CAGR of 35%. Total revenues are projected to be about
INR420 bn for FY10.
Figure 13: Revenue projections
INR mn FY07 FY08E FY09E FY10E CAGR (%)Total E&C 131,300 170,724 232,375 326,023 35.4
Total Electrical 18,450 24,908 32,380 42,094 31.6
Total MIP 17,950 22,012 27,028 33,231 22.8
Total Others 8,440 11,394 14,812 19,256 31.6Total 176,140 229,037 306,595 420,604 33.6Source: Company data, L Lehman Brothers estimates
We estimate that the share of exports in terms of total sales will go up from 18% currently
to 20.4% by FY10. We believe that due to high inflection in the planned investments
and thus available opportunities in the domestic infrastructure, it will be tough for the
company to increase its share of exports across segments significantly (although
management has guided to a higher share of exports of around 25% by FY10)
Figure 14: Revenues domestic and export breakdown
INR mn FY06 FY07 FY08E FY09E FY10ETotal domestic 121,220 144,680 190,635 246,827 334,746Total exports 26,420 31,460 38,402 59,769 85,858Total revenues 147,640 176,140 229,037 306,595 420,604% domestic 82.1 82.1 83.2 80.5 79.6
% exports 17.9 17.9 16.8 19.5 20.4
Source: Lehman Brothers estimates
Similarly, on the order inflows side, E&C segment is projected to have a significant share
in total order inflows with a CAGR of 32% against an overall order inflow annualized
growth rate of 31.3% over FY07-FY10.
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Figure 15: Order inflow estimates
INR mn FY07 FY08E FY09E FY10E CAGR (%)E&C Total 252,490 332,859 439,188 580,003 31.9
Electrical 22,030 29,740 38,662 50,261 31.6
MIP 21,433 26,283 32,272 39,679 22.8
Others 10,078 13,605 17,686 22,992 31.6Total 306,030 402,487 527,808 692,935 31.3Source: Lehman Brothers estimates
Note: order inflows figures are analyst estimates
As a result of increasing order book, the order book coverage ratio stands to improve
from current 2.09 to 2.46 by FY10, according to our estimates. We believe the
company has the necessary skill sets and resources to maintain a good efficiency ratio
across the next three years.
Figure 16: Total order book coverage ratio
1.76
1.37
1.67
2.09
2.372.49 2.46
0
1
2
3
FY04 FY05 FY06 FY07 FY08E FY09E FY10E
(x)
Source: Lehman Brothers estimates
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Figure 17: Order backlog
148.2162.3175.1 174.3170.3 168.0 170.2 179.1
183.2198.7
235.3 246.6
283.2306.7
357.1368.0
416.3
0
50
100
150
200
250
300
350
400
450
J S D M J S D M J S D M J S D M J
(INR bn)
FY04 FY05 FY06 FY07 FY08
Source: Company data
Expanding margins
The core EBITDA margin expanded substantially in FY07 from 7.2% to 10.1%. The
margin improvements were on account of a favorable business environment as new
orders came in at higher margins, operating leverage and corporate initiatives started in
FY06 such as cost control and global sourcing. The full impact of the initiatives and
favorable business environment was realized in FY07. The business environment is
expected to remain robust. However, the delta in margins realized in FY07 is unlikely to
be repeated, in our view. We expect core EBITDA margins to expand from 10.1% in
FY07 to 11.3% in FY10. Historically we have seen margins moving in line with the order
book coverage ratio, and the trend is expected to continue in our projections as we
expect the order book coverage ratio to stabilize at around 2.5 going forward.
Figure 18: Margin projections
7.2
10.110.9 11.1 11.3
10.2
12.513.4 13.0 12.8
0
2
4
6
8
10
12
14
16
FY06 FY07 FY08E FY09E FY10E
Core EBITDA margins EBITDA margins
(%)
Source: Lehman Brothers estimates
Note: core EBITDA and EBITDA figures are analyst estimates
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We estimate EBITDA to grow at a CAGR of 34% over FY07-FY10, while we expect PAT
to grow by an annualized rate of around 32% over FY07-FY10 to reach INR32 bn at
the end of FY10. We project core EBITDA of INR24 bn and net profit of around
INR18.5 bn in FY08.
Figure 19: Growth in bottom line(%) FY05 FY06 FY07 FY08E FY09E FY10EGrowth in core EBITDA (YoY) 50.4 31.4 66.7 38.6 35.6 40.2
Growth in EBITDA (YoY) 22.7 44.1 46.9 37.0 29.7 35.5
Growth in PAT (YoY) 18.8 44.8 51.8 36.2 28.4 37.1
Source: Lehman Brothers estimates
Note: core EBITDA and EBITDA figures are analyst estimates
Improving profitability
We believe L&T will continue to offer healthy returns on equity over the next three years.We expect standalone RoE (taking out the effect of investments in subsidiaries and
dividends from subsidiaries) to expand from 30.5% in FY07 to about 41% in FY10. We
also expect return on capital employed to rise from 17% currently to around 21% in FY10.
Figure 20: Profitability forecast
21.4
30.8
35.2
39.0
41.6
15.8
17.7
18.8
18.9
20.8
15 20 25 30 35 40 45
FY06
FY07
FY08E
FY09E
FY10E
Return on equity Return on capital employed
(%)
Source: Lehman Brothers estimates
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L&T Infotech
We expect L&T Infotech to generate sales of INR18 bn in FY08E, with a margin
expansion of 60 bps over FY07.
Figure 22: L&T Infotech financials
FY05 FY06 FY07 FY08E FY09E FY10ERevenues (INR mn) 5,589 7,934 12,781 18,247 24,808 33,599
PAT (INR mn) 459 702 1,481 2,231 3,143 4,019
Margins (%) 8.2 8.8 11.6 12.2 12.7 12.0
Growth in PAT (%) 52.9 111.0 50.6 40.9 27.9
Source: Company data, Lehman Brothers estimates
However, we have downplayed significant margin expansion in L&T Infotechs business
due to considerable rupee appreciation pressure.
L&T Finance
We expect the book value of L&T Finance to increase to INR12 bn by FY10 and we
also factor in a steady increase in RoE from current 16.6% to around 23% in FY10.
Figure 23: L&T Finance projections
FY05 FY06 FY07 FY08E FY09E FY10ERevenues (INR mn) 1,100 1,491 2,754 4,957 8,427 12,641
PAT (INR mn) 240 351 626 1,100 1,854 2,781
Growth in PAT (%) 78.8 46.2 78.2 75.8 68.5 50.0
Shareholder's funds (INR mn) 1,340 2,151 3,777 7,377 9,231 12,012
RoE (%) 17.9 16.3 16.6 14.9 20.1 23.2
Leverage 4.90 5.32 6.84 5.67 6.26 6.15
Source: Company data, Lehman Brothers estimates
Note: RoE figures are analyst estimates
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Company background
Larsen & Toubro (L&T), incorporated in February 1946 is the among the largest E&C
companies in India today. It was converted into a public limited company in 1950. L&T
has no identifiable promoter group. Substantial amounts of shares are held by institutional
investors. The company is headed by Mr A.M.Naik, the Chairman and Managing
Director. L&T parent carries out its diversified activities through different divisions engineering and construction (E&C), electrical & electronics (E&E) and machinery &
industrial products. Furthermore, the company has subsidiaries and prominent among
them are L&T Infotech (IT services), L&T Finance (financial services), L&T-IDPL (developer of
infrastructure and real estate projects) and L&T International FZE (houses all international
subsidiaries). L&T is a market leader in the Indian engineering and construction industry
by virtue of its track record and its ability to offer a wide array of services. L&T has
expertise in design, engineering and construction across various industries, including oil
& gas, petrochemicals, refineries, fertilizer, metals and power. L&T has a dominant
position in the oil and gas and metals space in India. L&T is among the largest players in
the domestic infrastructure sector and has a presence across all segments, namely, roads,ports, urban infrastructure, airport, water and sanitation and railways. L&T is also a
market leader in electrical and electronics systems in India.
L&T has a well-diversified business mix. It is present across industry and infrastructure
segments. Its presence ranges from design and construction to manufacturing and
services. Some 82% of the revenues on a standalone basis accrue from the domestic
market (FY07). However, it is steadily increasing its presence in the international market
(mainly in the Middle East and China) through its E&C division and through its
subsidiaries and joint ventures.
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Figure 24: Company structure
LTLT
Engineering and
Construction
ECC
E & CP
HED
Engineering and
Construction
ECC
E & CP
HED
Electrical and electronicsElectrical and electronicsMachinery and industrial
products
Manufacturing
Trading
Machinery and industrial
products
Manufacturing
Trading
SubsidiariesSubsidiaries
LT InfotechLT InfotechLT IDPL
Infrastructure
LT-UIL
LT IDPL
Infrastructure
LT-UIL
Financial Services
LT Finance
LT Infra Finance
Financial Services
LT Finance
LT Infra FinanceManufacturing subsManufacturing subs
Foreign subsidiries
ME
China
Foreign subsidiries
ME
China
Source: Company
Engineering and construction
E&C is L&Ts core business, accounting for 75% of its standalone revenues. This business
is sub-divided into three operating divisions (ODs): engineering construction & contracts
(ECC), E&C projects and heavy engineering.
Engineering Construction & Contracts division (ECC)
ECC is one of the largest construction organisations in India. ECC undertakes projects on a
lump-sum turnkey basis. This involves engineering, design and the construction of infrastructure
and industrial projects covering civil, mechanical, electrical and instrumentation disciplines.The ECC division has been further divided into five business sectors:
Industrial projects and utilities (IPU): This unit focuses on thermal power, minerals &metals, bulk material handling and water supply. The unit is involved in engineering,
design and construction of facilities in these sectors. Planned investment in power,
metals and water supply sector is expected to be 2.13x, 5.6x and 3.12x,
respectively, in XI plan compared to X plan.
Building and factories (B&F): As the name suggests, this unit is involved ininstitutional & commercial buildings, system housing and industrial structures. There is
huge demand for office space by IT and ITES (Information Technology and EnabledServices) businesses, driving growth in this business segment. The company has
established offices in the UAE and Oman to capitalize on the potentially favorable
international business opportunities. Omans investment in its residential and
commercial real estate is estimated to be US$460 bn over the next five years
compared to US$230 bn in the past five years.
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Transportation Infrastructure (TI): All transportation projects such as roads, bridges,ports and airports fall under this unit. In the past few years, activity in this sector has
been strong, especially in the roads sector. Investment in roads in the XI plan is
estimated at INR3,118 bn, up 140% from the previous plan. Similarly, investment in
ports and airports in the XI plan is expected to be INR739 bn and INR347 bn,
respectively. This is an increase of 1,270% and 295% over the X plan, respectively.
Power transmission and distribution (PT&D): The division focuses on electricity T&Dsegment. We expect this segment to attract huge investment under grid strengthening
and rural electrification projects. It also focuses on railway business in view of
substantial growth initiatives in the railways, such as feeder route electrification and
dedicated freight corridors.
Hydro-electric (hydel) and nuclear sector (H&N): The opportunities in the hydelpower continue to be attractive with the Indian government placing greater emphasis
on hydel projects. About 16,000 MW of Hydel power capacities are being
planned in the XI Five year plan. With continuing progress in the Indo-US nuclearpower co-operation treaties, there are considerable expectations on the growth of
nuclear power in India and the unit expects to play a significant role in future nuclear
power projects.
Engineering & Construction Projects (E&CP)
The engineering & construction projects OD undertakes EPC (engineering, procurement &
construction) projects in select sectors, such as oil & gas, power and minerals. The
division has design centres in Mumbai, Baroda, Delhi and Abu Dhabi. It is also
strengthening its operations in the Middle East to tap new opportunities in new capacity
creation, clean fuel projects and downstream petrochemicals.
This OD takes up EPC projects and then procures components and subcontracts works to
the most efficient supplier. This subcontracting is not necessarily done within L&T. All
areas in which this SBU operates are seeing significant activity and the outlook is very
robust, in our view.
Hydrocarbon and Power (HC&P): Refineries and petrochemical complexes formpart of this unit. L&T is particularly strong in processes and offshore platforms. We
estimate planned investment in the Indian oil and gas space to be INR4,004 bn
over the next five years which 2.24x the investment in the last five years.
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Heavy Engineering Division (HED)
HED manufactures and supplies custom-engineered critical equipment and systems to
sectors like fertilizer, refinery, petrochemical, chemical, oil & gas, thermal & nuclear
power, aerospace, and equipment & systems for defence applications. It also plans to
start shipbuilding activities for the construction of special commercial vessels and
warships for the Indian navy and the coast guard.
The division has manufacturing and fabrication facilities located at Mumbai, Hazira and
Baroda (Gujarat) and Vishakhapatnam (Andhra Pradesh). It has also started construction
work for a precision manufacturing facility at Coimbatore in Tamilnadu, which will cater
to the needs of aerospace, aviation, nuclear power and sub-systems for defence.
According to the Ministry of defence, the defence sector is expected to be opened up for
private participation very soon. The process for granting Raksha Udyog Ratna (RUR)
status to selected technology players has been initiated. In addition, the offset policy is
expected to throw up significant opportunities for the division in the medium to long term.
High crude prices have renewed interest in gas and coal-based projects. This has
resulted in strong growth in this divisions exports. The Middle East, China and South
America are likely to be the major export markets.
Joint ventures
The key strength of L&Ts E&C business is its leadership in technology and engineering.
The company has continuously upgraded its technology in various areas by entering into
JVs with companies that are leaders in their areas of operation. The revenue and profit
contribution from these JVs is insignificant to the P&L, but they bring in skill sets that enableL&T to maintain its market leadership. L&Ts key joint ventures are:
L&T Chiyoda Ltd: This is a 50:50 JV with Chiyoda Corporation of Japan. The JVoffers IT-enabled services and engineering services to process industries such as
petroleum refineries, chemical & petrochemical units, fertilizer companies and oil &
gas firms. The company has a high-end engineering centre at Mumbai. The
company reported revenues of INR530 mn and net profit of INR78 mn in FY07 up
from INR342 mn and INR39 mn in FY06, respectively. Voith Paper Technology (India) Ltd: L&T and Voith Paper of Germany hold equal
stakes in this JV. The JV provides comprehensive technology solutions to the paper
industry, covering the entire production process from fiber to paper. The company
has become a supplier of choice to the paper industry for its technological
leadership. In FY07, the JV reported revenues of INR308 mn and net profit of
INR89 mn up from INR149 mn and INR32 mn in FY06, respectively.
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L&T Ramboll Consulting Engineers Ltd: L&T and Ramboll A/S of Denmark holdequal stakes in this JV. It offers engineering and project consultancy services for
transportation infrastructure projects in the civil engineering domain. The JV had sales
of INR164 mn and profit of INR29 mn in FY07 up from INR151 mn and INR10 mn
in FY06, respectively.
L&T Valdel Engineering Private Ltd: This a 50:50 joint venture between L&T andValdel Corporation Ltd. This JV provides the following services to process and well-
head platforms: a) front-end engineering & design (FEED); b) detailed engineering
services; c) procurement engineering services; d) project management services; and
e) the revamping of platforms and pipelines. The JV had sales of INR250 mn and
profit of INR40 mn in FY07 up from INR156 mn and INR32 mn in FY06,
respectively.
HPL Cogeneration Limited (HPLCL): A 51% subsidiary, it is a joint venture betweenL&T and Haldia Petrochemicals Limited, Kolkata, for operating a 116 MW
combined cycle cogeneration power plant at Haldia, West Bengal. The electric
power and steam generated by the plant are supplied exclusively to the
petrochemical complex of Haldia Petrochemicals Limited (HPL). The company had
sales of INR1,688 mn and profit of INR905 mn in FY07 compared to
INR1,714 mn and INR970 mn in FY06, respectively.
L&T-Sargent & Lundy Limited (LTSL): LTSL is a joint venture with Sargent & Lundy LLC(S&L), USA. It provides power plant engineering services to its parent companies as
well as to a few niche customers in India and abroad. The JV had sales of
INR229 mn and profit of INR12 mn in FY07 up from INR130 mn of revenue and a
INR46 mn loss in FY06.
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Figure 25: E&C JVs
Revenues(INR mn) PAT(INR mn) Margins(%) Growth YoY(%)FY06 FY07 FY06 FY07 FY06 FY07 Revenues PATL&T Chiyoda 342 530 39 78 11.4 14.7 55 100
Voith 149 308 32 89 21.5 28.9 107 178
L&T Ramboll 151 164 10 29 6.6 17.7 9 190
L&T Valdel 156 250 32 40 20.5 16.0 60 25
HPLCL 1,714 1,688 970 905 56.6 53.6 -2 -7
L&T Sargent & Lundy 130 229 -46 12 -35.4 5.2 76 NA
Source: Company data
We expect L&Ts E&C order inflows to grow 2.4x during FY08-FY10 compared tothe past three years
We project E&C order inflow of INR1352 bn over FY08-10, which is 2.33x the order
inflow over FY05-07. We expect domestic E&C projects to add INR1,070 bn to L&Ts
order book over FY07-10 which is 2.27x the order inflow in the pervious three years.
The rise in order inflow is broadly in line with our expectations on the inflection in
industrial capex and infrastructure investments. Of the overall projected increase in order
inflows, we believe that around 83% would come from the E&C division.
Figure 26: E&C order inflows
INR bn FY04 FY05 FY06 FY07 FY08E FY09E FY10EDomestic E&C 98 114 151 206 268 349 453
Exports E&C 19 17 34 46 65 91 127
E&C Total 117 131 185 252 333 439 580
Others 16 18 39 54 70 89 113
Total 133 148 224 306 402 528 693% from E&C 87.7 88.1 82.6 82.5 82.7 83.2 83.7
% from domestic E&C 73.5 76.7 67.5 67.4 66.6 66.0 65.4
Source: Lehman Brothers estimates
Note: order inflows figures are analyst estimates
We expect L&Ts other divisions to show a significant pick-up in growth momentum in the
next three years, but we believe E&C would still remain the key business driver for the
company. We project a stable share of E&C business in L&Ts order inflows of around
82-84%. However, within E&C, as management starts focusing on the international
market, we expect the share of exports to rise, although not significantly, due to expectedhigh volumes in domestic business.
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30 October 16, 2007
Figure 27: Total order inflows and CAGR
INR bn CAGR (04-07) CAGR (07-10) Total (05-07) Total (08-10 ) InflectionDomestic E&C 28.1 30.0 471 1,070 2.27
Exports E&C 34.9 40.0 97 282 2.91
E&C Total 29.3 31.9 568 1,352 2.38
Others 48.2 28.2 110 271 2.46Total 31.9 31.3 678 1,623 2.39% from E&C 83.8 83.3
% from domestic E&C 69.5 65.9
Source: Lehman Brothers estimates
Note: order inflows figures are analyst estimates
We project that the next three years will see similar growth to that achieved in the
previous three years, and as mentioned, exports should show a further pick-up, with an
FY07-FY10E CAGR of 40%, compared to annualized growth of 35% in the previous
three years.
Order book coverage to remain around 3x
The order book coverage ratio reached an inflection point in December 2006 as
depicted in the following chart. The order book coverage ratio currently stands at 3.67.
We expect the order book coverage to remain above 3 over the next two years.
Figure 28: E&C order book coverage ratio
1.81.6 1.5 1.5 1.5 1.6
1.9 1.92.2
2.3
2.7 2.6
3.7
3.0 3.1 3.0
0
1
2
3
4
Jun-04
Sep-04
Dec-04
Mar-05
Jun-05
Sep-05
Dec-05
Mar-06
Jun-06
Sep-06
Dec-06
Mar-07
Jun-07
FY08E
FY09E
FY10E
(x)
Source: Lehman Brothers estimates
We expect a revenue CAGR of 34% over FY07-FY10E
We expect domestic E&C revenues to grow at 34% p.a. over FY07-10. We are
building in a drop in execution rate from 54.3% in FY07 to 45.1% in FY10. Execution
rate is defined as current year sales as percentage of start of the year order book.
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Figure 29: E&C revenue projections
INR bn FY07 FY08E FY09E FY10E CAGR (%)Domestic E&C 108 143 186 258 33.7
Exports E&C 24 28 46 69 42.4
Total E&C 131 171 232 326 35.4Total 176 229 307 421 33.6Source: Company data, Lehman Brothers estimates
The domestic E&C business is expected to grow its revenues at a CAGR of 33.7% over
FY07-FY10, while we project exports to show a much higher annualized growth rate of
42.4% over the next three years.
Solid expansion in margins
The following chart depicts the expansion in the E&C EBITDA margin since September
FY06. Given the seasonality in margins, we have clubbed similar quarters together in the
chart. The margin improvements were on account of a favorable business environment as
new orders came in at higher margins, operating leverage and corporate initiatives
started in FY06 such as cost control and global sourcing. The full impact of the
initiatives and favorable business environment was realized in FY07. The business
environment is expected to remain robust. However, the delta in margins realized in
FY07 is unlikely to be repeated, in our view. We expect only a marginal improvement in
EBITDA from here on.
Figure 30: E&C EBITDA margins
7.16.36.5
5.3
6.65.9
3.9
5.64.8
6.0
7.98.4 8.6
9.6
6.6
11.1
11.711.7
11.8
14.7
11.4
0
5
10
15
June Sept Dec Mar
FY03 FY04 FY05 FY06 FY07 FY08
(%)
Source: Company data
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32 October 16, 2007
Electrical & Electronics (E&E)
L&Ts E&E division makes low-tension switchgears, air circuit breakers, molded case
circuit breakers, switchboards and electronic control systems. The division also makes
petrol dispensing stations and energy meters. Around 66% of this segments revenues
come from switchgear products and it is expected to remain the key driver for future
growth in business. According to the company, it holds a market share of 35% in theIndian low voltage switch gear segment. The company is now planning to move into
medium voltage segment. One of the key strengths of L&T is its very strong distribution
network. It has 500 authorized stockists, one of the largest networks in the country for
switch gears. The division is also investing in innovation and new product development.
Almost a quarter of FY07 sales came from products developed in the past five years.
Significant contribution to revenues and EBITDA, good margins
The division contributed 10% of L&Ts revenues and 14% of its EBITDA in FY07 (down
from 10.3% and 17%, respectively, in FY06). It also improved its EBITDA margins from
16.7% in FY06 to 17.3% in FY07.
Figure 31: E&E EBITDA margins
13.7
16.7 17.3
0
5
10
15
20
FY05 FY06 FY07
(%)
Source: Company data
Robust outlook: we expect a 33% revenue CAGR over FY07-FY10
Figure 32: E&E revenue outlook
INR bn FY05 FY06 FY07 FY08E FY09E FY10E Total (05-07) Total (08-10)Domestic Electrical 10 12 17 23 29 38 39 90
Exports Electrical 1 1 2 2 3 4 4 9
Total Electrical 11 14 18 25 32 42 43 99Total 131 148 176 229 307 421 455 956% to Total 8.1 9.4 10.5 10.9 10.6 10.0 9.4 10.4
Source: Company, Lehman Brothers estimates
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October 16, 2007 33
Given the huge outlay planned in real estate development (particularly housing) and
power, this business should see robust growth in the medium term. The current growth in
commercial and residential complexes, malls, IT parks, hospitals and stadiums, etc., has
increased demand for E&E products. The governments thrust on the power sector through
the Accelerated Power Development and Reforms Programme (APDRP) and rural
electrification schemes represent a significant revenue opportunity for this division, in our
view. Outside of India, Chinas strong economic growth has boosted demand forproducts offered by the industry. Countries in the Middle East are also making large
investments in the development of infrastructure, power, desalination plants, refineries
and other areas.
We project the segments revenue CAGR of 33% over FY07-FY10. Also, the contribution
of the segment to total revenues is expected to remain around 10% (revenues over the
next year are expected to double from INR455 bn over the last three years FY05-FY07).
Fits into L&Ts long-term strategy
The business augments L&Ts capabilities in the industrial sector, and also fits in with the
companys long-term objective to increase the contribution of manufacturing to its overall
revenues. The company is expanding its capacity at the Ahmednagar plant, and
constructing a new one at Coimbatore. It is also expanding its product portfolio; its
acquisition of Datar Switchgear Ltd last year is one move in this direction (the activities of
Datar have been fully integrated after completion of acquisition process). The acquisition
adds products such as miniature circuit breakers and earth leakage circuit breakers to
L&Ts portfolio.
Increasing international presence
In order to increase its international presence in this segment, L&T recently set up a
manufacturing facility for high-end air circuit breakers in China. It has also entered into ajoint venture with Kanoo Group of Saudi Arabia to manufacture switchboards and motor
control centres in that country.
Machinery and Industrial Products (MIP)
Machinery and Industrial Products Division (MIPD) is organized into three main business
sectors: 1) construction equipment business, 2) industrial products and 3) industrial
machinery.
The division is involved in manufacturing, trading and servicing. Trading and servicing
accounts for 70% of the segments revenues (FY07). This division was created with a
view to consolidate L&Ts construction and mining equipment businesses. The divisionmarkets and provides support for construction and mining equipment, valves, plastic
processing machinery, and welding products. These products are made by L&Ts 50%-
owned JVs listed below. Most of these associates would take care of the manufacturing
part, and L&T normally does the sales servicing and marketing of the products. (except in
L&T case and Tractor JV where marketing is done by the JV itself)
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34 October 16, 2007
Figure 33: JV performance
Revenues (INR mn) PAT (INR mn) Margins (%) Growth YoY (%)FY06 FY07 FY06 FY07 FY06 FY07 Revenues PATL&T Komatsu 5,350 8,060 401 584 7.5 7.2 51 46
Audco 5,790 6,890 432 523 7.5 7.6 19 21
L&T Demag 1,120 1,400 29 32 2.6 2.3 25 12
EWAC Alloys 741 1,090 145 226 19.6 20.7 47 56
L&T case equipment 1,770 3,240 9 145 0.5 4.5 83 1606
Tractors Engineers Limited 769 1,030 54 133 7.0 12.9 34 146
Source: Company
Figure 34: Manufacturing JV subsidiaries and associates
JV JV partner
L&T Komatsu Komatsu, Singapore Hydraulic excavators and components.
Audco India Limited Flowserve group, USA Industrial valves, safety systems and pneumatic actuators
L&T-Demag Demag Ergotech, Germany Injection molding machines for plastic industry
EWAC Alloys Eutectic and Castolin group Electrodes, welding wires, wear plates and welding equipmentL&T Case Equipment CNH American LLC Earthmoving equipment such as loader backhoes and vibratory compactors
Source: Company
L&T Komatsu: JV with Komatsu Singapore. The company manufactures hydraulicexcavators and other associated components. The JV had sales of INR8.06 bn and
profit of INR584 mn in FY07 up from INR5.35 bn revenues and INR401 mn PAT in
FY06. The outlook for this JV remains robust, in our view, with the introduction of new
products and strong outlook on mining and construction business.
Audco India Limited: It is L&Ts JV with Flowserve group which manufactures industrialvalves, safety systems and pneumatic actuators. The company has significant presence
in the international market, with more than half of revenues coming from exports. It
recorded sales of INR6.89 bn in FY07, a YoY growth of 19%. Profit at INR523 mn,
increased by 21% YoY. We expect growth to be sustained over the medium term,
driven by robust activity in oil & gas and plans of the Flowserve group to increase its
outsourcing in EU and US.
L&T-Demag: JV with Demag Ergotech of Germany manufacturing injection moldingmachines for plastic industry. The applications for these products span automobiles,
electrical goods, packaging and personal goods industry. In FY07, revenues wereINR1.40 bn up from INR1.12 bn in FY06 and profit after tax was INR32.4 mn as
compared to INR29.0 mn in FY06. The company expects demand from
manufacturing to shift to low-cost geographies like India.
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Figure 35: MIP EBITDA margins
11.9
14.7
18.0
0
5
10
15
20
FY05 FY06 FY07
(%)
Source: Company data
Expect revenue growth of 33% over FY07-FY10
Figure 36: MIP revenue projections
INR bn FY06 FY07 FY08E FY09E FY10E Total (06-07) Total (08-09)Domestic MIP 11 13 16 19 23 24 35
Exports MIP 4 5 6 8 10 8 14
Total MIP 14 18 22 27 33 32 49Total 148 176 229 307 421 324 536% to Total 9.7 10.2 9.6 8.8 7.9 10.0 9.2
Source: Company data, Lehman Brothers estimates
We expect the revenue contribution of this segment to be around INR536 bn as
compared to INR324 bn in the past two years, but as a percentage contribution of total
revenue stream, we expect it to come down marginally from the current 10% to around
9% in the next three years on the back of strong E&C segment growth. Capacity
additions in steel & cement should result in increased privatized mining. Demand for such
equipment is expected to mimic investment in industrial capex and infrastructure, in our
view.
Larsen & Toubro Infotech
Focus on manufacturing and engineering-related industries
L&T Infotech is a fully owned subsidiary of L&T. L&T had revenues of US$320 mn on a
standalone and US$360 mn on consolidated basis (FY07). L&T InfoTechs serviceoffering includes that of a typical IT service provider, including application development
and maintenance, ERP, data warehousing, business intelligence, high-end KPO/BPO,
testing and infrastructure management services. However, in terms of verticals, the focus
is more on manufacturing and engineering-related industries.
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October 16, 2007 37
Figure 37: L&T Infotech vertical wise revenues FY07
Manufacturing,
(0.32)
Others, (0.01)
Product Engineering
Services, (0.17)
Insurance, (0.23)
Banking and FS,
(0.10)
Energy and
petrochemicals,
(0.17)
Source: Company data
Strong growth in revenues
L&T Infotechs revenues have grown at an annualised rate of 52% over the period FY04-
FY07. Manpower increased from 2,491 in FY04 to 7,383 as of June 2007. Employee
productivity, which we define as revenues per average employee is at INR1.88 mn/
employee, in line with other top-tier IT companies. Exports accounted for 97% of the
companys revenues, with the US contributing 73% of revenues (FY07). Offshore
development centers accounted for 43% of the companys exports.
Improving profitability
Profitability has also improved significantly. The company recorded a net margin of
11.6% in FY07, which is lower than the margins of other mid-tier IT services companies,but a substantial improvement over its own margin of 8.8% in FY06. However, with
appreciation of the rupee against the US dollar, we do not expect significant margin
expansion FY08. In fact, in Q1FY08, PAT margins were 11.85%, a drop of 65 bps
YoY. We expect margins to be in the range of 12-12.5% over the next couple of years.
The RoE of the business has increased from 39% in FY05 to 44.5% in FY07. The rise in
profitability is despite the fall in leverage. Net debt to equity is down to 0.17 from 0.66
in FY05.
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38 October 16, 2007
Outlook: Revenue growth likely to remain strong
Figure 38: Revenue projections L&T Infotech
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
FY05 FY06 FY07 FY08E FY09E FY10E
3
6
9
12
15
Revenues Margins(INR mn) (%)
Source: Lehman Brothers estimates
We expect growth momentum to continue, and project an annualized revenue increaseof 35% over FY07-FY10 in rupee terms. Any appreciation of the rupee would negate the
positive impact of operating leverage. We expect net margins to remain compressed;
however the company expects margins to be higher because of improved resource
utilization. L&T Infotechs resource utilization is currently at 66% compared to the industry
average of 75%.
L&T has of late renewed its focus on the IT business, and set a revenue target of US$1
bn by FY10. The increase in headcount, from 2,491 as at end-FY04 to 7,383 as at
end-June 2007, reflects managements confidence in this companys prospects. The
company is also open to inorganic growth opportunities. In fact, L&T Infotech recentlyacquired GDA Technologies, of the US for US$27 mn. GDA Technologies had revenues
of INR921 mn in FY07.
L&Ts management has indicated that it will float an IPO of L&T Infotech some time in
second half of 2008. This should lead to value unlocking for this subsidiary.
L&T Finance (LTF)
LTF, a wholly owned subsidiary of L&T, is a non-banking finance company (NBFC),
offering a wide range of financial products, such as like financial lease, operating lease,
hire purchase, term loans, bills discounting, etc. to cater to varied needs of customers.
The main driver of growth in this business is construction equipment finance, which is
slated to grow over 20% over the next three years. With huge spending in roads, ports,
irrigation, mining and housing sectors coming up, coupled with increasing demand from
the parent company businesses and capital expenditure by corporates, the segment is
expected to grow at more than 50% p.a. for the coming three years.
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October 16, 2007 39
LTF has also been able to gain a significant market share in the commercial vehicles
segment and has extended its tractor finance products to cover tractors and farm
implements of all leading original equipment manufacturers. It is also keen on expanding
into rural markets which will cater to additional opportunities.
Strong growth
LTF registered significant growth in disbursements across its key business segments such
as corporate finance, construction equipment finance, tractor finance and commercial
vehicle finance last year The segments revenues grew by 85% from INR1.49 bn in
FY06 to INR2.75 bn in FY07. Profits also increased by 78% to INR626 mn this year
from INR351 mn last year.
Figure 39: L&T Finance performance Figure 40: L&T Finance Asset size
110
149.1
275.4
2435.1
62.6
0
75
150
225
300
2004-05 2005-06 2006-07
Income PAT(INR crores)
2922
1345.7
853.3
0
1,000
2,000
3,000
2004-052005-062006-07
(INR crores)
Source: Company data Source: Company data
L&T IDPL
L&T IDPL is the holding company for all of L&Ts BOT projects. Going ahead, all of the
BOT projects being executed by L&T except power projects would be housed in L&T
IDPL. IDPLs portfolio currently comprises projects in the roads, ports and airport sectors.
L&T currently holds 78.4% of L&T IDPL. The remaining 21.6% is held by private equity
investors JP Morgan Chase and IDFC.
L&T-IDPL in turn hold stakes in SPV (Special purpose Vehicles) that house infrastructure
projects and L&T Urban infrastructure. Each SPV houses one infrastructure project.
Currently, L&T-IDPL holds stakes in 18 SPVs that house infrastructure projects. In ten ofthese SPVs, L&T IDPL holds a majority stake (>=50%). Most of the investments so far have
been in the road sector. L&T- Urban Infrastructure Ltd (L&T-UIL) was formed in March
2006 and houses all real estate projects. L&T IDPL holds a 75% of stake in L&T-UIL, with
the remaining being held by the strategic partner HDFC.
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40 October 16, 2007
Many of the BOT projects are expected to be operational by end 2009
Of the 33 entities (Infra SPVs and projects under L&T-UIL), 14 are already operational.
The remaining are under implementation. Many of these BOTs are expected to be
operational by end 2009. Once the projects are commissioned and cash flows start
accruing the valuations are expected to rise significantly as risk drops, in our view.
L&T IDPL intends to hold majority stake in the projects
As a policy, L&T-IDPL intends to hold majority stakes in most of the projects. The projects
in which it currently has a minority stake, it either intends to exit or acquire additional
stake to attain majority. Recently L&T-IDPL exited from some projects- Jaipur Kishangar
Expressway Limited, Gujarat Toll Road Investment Company Ltd and Vishakhapatnam
Industrial Water Supply Company Ltd where it held minority stakes.
INR4-5 bn equity investment by L&T-IDPL every year over next three years
L&T-IDPL intends to invest INR 4-5 bn as equity in various infrastructure and real estate
projects. The equity may be invested by the current PE investors in L&T-IDPL so that theshareholding structure of L&T-IDPL remains unchanged.
As per the recent consultation paper from the planning commission, the private investment
in infrastructure other than power is estimated at INR1278 bn over the next three years.
Assuming a debt:equity of 80:20, equity investment shall be INR256 bn. LTIDPLs equity
investment of INR12 bn (INR4 bn every year in infrastructure other than power over next
three years) over next three years represents a market share of only 4.7%. Therefore, we
believe that there exists potential upside to the investment by L&T-IDPL in the infrastructure
projects.
Benchmark equity IRR of 18%
For all projects where L&T-IDPL takes the traffic risk, the benchmark equity IRR of
investment in the projects is 18%. For urban infrastructure projects, the company is
targeting higher returns in excess of 22%. The potential returns are greatest in airport
and ports. In airports, equity returns can be as high as 25-30%. In ports, the returns are
in the range of 18-22%. Projects in roads, electricity transmission and railways entail
lower equity IRR, in our view.
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October 16, 2007 41
International Operations
Currently 18% of the revenues come from international operations. The focus regions for L&T
in export market are the Middle East and China. In the Middle East, the company intends
to participate in the investment boom in the region. Based on the upcoming projects in the
Middle East, MEED project estimates that the overall investment in oil and gas,
petrochemicals, power, industry and construction shall be more than US$1 tn over the nextsix years. The Middle East currently accounts for almost half of the companys international
revenues. L&T has set up a design center in Sharjah to cater to the requirements of the
region.
China is being looked at both as a market and sourcing and global manufacturing hub.
L&T has set up a manufacturing plant in China Wuxi Electric Company for the
manufacture of switch gear products; an industrial valve manufacturing company in
Jiangsu and Rubber Machinery Company in Qingdao. There is a three-pronged strategy
for the China market: a) compete directly to compete directly in the Chinese market
with its own pro