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S. Vaidya Nathan

Mr A. M. Naik, Chairman and Managing Director... Focus on the engineering construction business is reflected in the strong order-book position.

SHAREHOLDERS of Larsen & Toubro may remain invested in the stock, as there appears to be scope for gains over a one/two-year perspective.

The company's performance so far this fiscal points to a substantial scaling up of revenues and earnings. Its impressive order-book position is bound to ensure healthy revenue growth over the next two years. The principal risk to profitability is the possibility of a rise in input costs and the company's inability to pass it on .

There have been several buy recommendations outstanding on the stock from about Rs 400 before the demerger and from about Rs 750 after the stock was listed as a pure engineering and construction play.

We remain bullish on the prospects for the company and the likely level of institutional investor interest; the near-term view is tempered by the possibility of downside linked to the volatile trends in the broad market.

Any weakness from the current levels could be used to accumulate exposure. The stock has consistently traded at upwards of Rs 700 after its listing as an engineering and construction play. As expected, there has been a surge in investor interest in the stock and a willingness to pay a higher price for the stock of a company whose earnings card has to suffer the losses of the cement business.

The stock trades at a price-to-earnings multiple of less than 15 times its likely FY-06 earnings estimated on a conservative basis. The company appears well set to report a growth of at least 30 per cent in sustainable earnings in FY-05; the bottomline and cash flows would also be bolstered by the gains made from sale of a part of its stake in Ultra-Tech Cement (the entity that owns the cement business of L&T) to Grasim Industries, which has acquired control over Ultra-Tech.

As a focussed play, L&T has moved aggressively to capitalise on its track record and scale up its order-book. Over the next 12 months, too, we expect addition to the order-book. The healthy trends in industrial growth, a renewed thrust on infrastructure with the possibility of incentives in the coming Budget, and the still nascent recovery in industrial investment, are positive factors for Larsen & Toubro.

In the West Asian region, L&T is well-placed to ride the construction boom set off by high oil prices. The company has implemented several projects successfully over the years and these are bound to serve as a reference point to augment its share of the construction business. It has consistently proven its ability to win orders at competitive rates in bidding without sacrificing on profitability levels.

This, coupled with the focus initiated on other geographies, are likely to bolster revenues from overseas markets.

By mobilising about Rs 675 crore through an offer of foreign currency convertible bonds in the last quarter of 2004, Larsen & Toubro has strengthened its balance-sheet and the ability to bid for big-ticket contracts.

The bonds are convertible into equity at Rs 1,122 per share and may also be redeemed after three years. They have been sourced at attractive rates reinforcing the company's ability to access capital cheaply.

This is likely to remain a core strength as the earnings card and cash flows now offer greater comfort to would-be lenders and investors.

The recommendation does not factor in any interest that could be shown by global majors in picking up a sizeable stake in the company; about 85 per cent of its equity is available for trading.

The stake of less than 15 per cent held by a trust of employees of the company is unlikely to be a deterrent to a serious bidder.

Any such bid is now in the realm of speculation. But given the robust fundamentals and strength in the engineering-construction business space, this possibility cannot be ruled out.

If any such interest emerges, it would provide a substantial upside to the stock price.

Even as shareholders ought to take this factor into account, they could retain their exposures to reap steady returns linked just to fundamentals.

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