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Equity|India|CapitalG

oods

Important disclosures can be found in the Disclosures Appendix.

Larsen & ToubroOn trackLarsen reported an in-line 2Q adjusted for one offs, though margin expansion

was subdued due to the non-engineering segments. We believe the company is

on track to meet its guidance on order inflows and revenues. The medium-term

outlook is strong though near-term returns could be subdued. Hold maintained.

Key forecasts

FY09A FY10A FY11F FY12F FY13FRevenue (Rsm) 339,385 370,348 441,052 574,164 647,631EBITDA (Rsm) 39,222 48,156 57,108 71,368 86,276Reported net profit (Rsm) 34,817 43,755 39,574 49,142 59,800Normalised net profit (Rsm) 27,070 31,251 38,157 49,142 59,800Normalised EPS (Rs) 45.20 51.80 63.30 81.50 99.10Dividend per share (Rs) 10.20 12.50 14.00 15.40 18.60Dividend yield (%) 0.51 0.63 0.70 0.78 0.93Normalised PE (x) 44.00 38.40 31.40 24.40 20.10EV/EBITDA (x) 30.80 24.30 20.40 16.30 13.20Price/book value (x) 9.56 6.55 5.65 4.78 4.03ROIC (%) 29.80 21.40 21.70 24.10 24.401. Post-goodwill amortisation and pre-exceptional itemsAccounting standard: Local GAAPSource: Company data, RBS forecasts

year to Mar, fully diluted

2Q earnings in-line adjusted for one offs

L&T reported 2Q11 sales of Rs93.3bn (up 17.8% yoy) ahead of our expectations driven by

strong growth in its core E&C business. Margins remained flat yoy, slightly below our

expectations, as lower manufacturing costs (as a percentage of net sales) offset higher staff

costs and other expenses. Reported profit came in at Rs6.9bn (up Rs25.5%yoy). Adjusting

for one offs in other expenses, other income and interest (cRs500m), profit was in line with

our estimates. Order inflow remained strong at Rs204.6bn (up 11.4% yoy); while the order

backlog stood at Rs1.154tn (up 41.4% yoy).

Comfortably placed on FY11 inflow guidance; execution cycle is lengthening

We believe the company is comfortably placed to meet its FY11 inflow guidance of Rs87bn

(up 25% yoy), given order inflows of Rs360bn in 1H11 (up 29% yoy) and with projects like

the cRs120bn Hyderabad metro order (for which L&T is the lowest bidder). The current order

book (at Rs1.15trn) is at an all time high. However, the inflow is being skewed graduallytowards the power sector and large orders, which will lengthen the execution cycle for the

company. Execution time for the current order book is 27 months as compared to 22 months

one year ago.

Macrooutlook remains exciting, but medium-term return ratios could be subdued

The macro outlook for L&T remains exciting, in our view, given the strong pipeline of projects

in the infrastructure space. This is positive for the company not only as an engineering

contractor, but also as an asset owner and developer. However, while the company does not

need immediate funding, it may have to shore up its balance sheet as it wins more such

projects. This may lead to continued fund raising, which might dampen return ratios in the

medium term until projects start yielding cash flows. This, in our view, will limit valuation

upside. We roll forward our DCF valuation of the standalone business by a quarter, which

takes our target price to Rs1,928. We maintain our Hold rating on the stock.

18 October 2010

Researched by

RBS Equities (India) LimitedInstitutional Team

Mafatlal Chambers C Wing, GroundFloor, N.M. Joshi Marg, Lower Parel (E),

Mumbai 400 013, India. Tel : +91 0226754 8411 Fax : +91 022 6754 8420

www.rbs.in/broking

Price performance

(1M) (3M) (12M)

Price (Rs) 1918 1874 1693

Absolute (%) 3.7 6.1 17.5

Rel market (%) 0.5 -5.6 0.4

Rel sector (%) -4.9 -9.3 13.9

500

1000

1500

2000

2500

Oct 07 Oct 08 Nov 09

LART.BO Sensex

Market capitalisation

Rs1.20t (US$27.07bn)

Average (12M) daily turnover

Rs2650.40m (US$57.70m)

Sector: BBG AP Eng & MachRIC: LART.BO, LT INPriced Rs1988.60 at close 15 Oct 2010.Source: Bloomberg

HoldTarget price

Rs1928.00 (from Rs1912.00)

Price

Rs1988.60

Short term (0-60 days)

n/a

Market view

Underweight

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Larsen & Toubro | Company Dynamics | 18 October 2010

2

In line results

L&T reported 2Q11 earnings in line with our estimates adjusted for one offs. We believe

that the company is well placed to meet its FY11 revenue and order inflow guidance as

execution and order flow pick up in 2H11. Hold maintained.

Execution surprises in 2Q11; but earnings were in line

L&T reported 2Q11 sales of Rs93.3bn (up 17.8% yoy) driven by strong growth in its core E&C

business. Margins remained flat yoy, as lower manufacturing costs (as % of net sales) offset

higher staff costs and other expenses (other expenses included exchange related losses

cRs600m) during the quarter. Other income saw a sharp jump during the quarter to Rs3.8bn (up

80.5% yoy) but included one off income of Rs700m due to the sale of its Satyam stake and other

assets. Interest costs also increased during the quarter to Rs1.9bn (up 53% yoy) but included a

R320m one-off related to employee provident funds. Higher-than-anticipated other income meant

that profit for the quarter came in at Rs6.9bn (up Rs25.5% yoy).However, adjusting for one offs in

other expenses, other income and interest (cRs500m), profit was Rs6.54bn, up 18% yoy. Order

inflow for the quarter remained strong at Rs204.6bn (up 11.4% yoy); while the order backlog stood

at Rs1.154tn (up 41.4% yoy).

Table 1 : 2Q11 and 1H11 performance

Rsm 2Q11 2Q11 yoy 1H11 1H10 yoy

Order inflow 204640 183650 11.4% 360,900 279,360 29.2%

Order backlog 1153930 816230 41.4% 1,153,930 816,230 41.4%

Net sales 93,308 79,212 17.8% 172,161 153,295 12.3%

Expenditure 83,251 70,829 17.5% 152033 136593 11.3%

as a % of net sales 89.2% 89.4% -20bp 88.3% 89.1% -80bp

Consumption of raw materials 69857 60473 15.5% 129297 117691 9.9%

as a % of net sales 74.9% 76.3% -148bp 75.1% 76.8% -167bp

Personnel cost 8,288 7,097 16.8% 13921 12212 14.0%

as a % of net sales 8.9% 9.0% -8bp 8.1% 8.0% 12bp

Other expenses 5,105 3,260 56.6% 8815 6690 31.8%

as a % of net sales 5.5% 4.1% 136bp 5.1% 4.4% 76bp

EBITDA 10,057 8,383 20.0% 20127 16702 20.5%

OPM 10.8% 10.6% 20bp 11.7% 10.9% 80bp

Other income 3,822 2,118 80.5% 6090 4345 40.1%

Depreciation 1,212 1,001 21.1% 2354 1939 21.4%

EBIT 12,667 9,500 33.3% 23863 19109 24.9%

Interest 1,932 1,263 53.0% 3355 2358 42.3%

Exceptional/Extraordinary items 708.4 273.8 158.7% 708 10473 -93.2%

PBT 11,444 8,511 34.5% 21,217 27,223 -22.1%Tax 3,794 2,707 40.2% 6905 5437 27.0%

Tax rate (%) 33.2% 31.8% 135bp 32.5% 20.0% 1257bp

Reported PAT 7,650 5,804 31.8% 14,312 21,786 -34.3%

Adjusted PAT 6,541 5,530 18.3% 13,203 11,314 16.7%

Source: Company data

Management confident on FY11 revenue; order book guidance

The company maintained its FY11 guidance of 20% revenue growth and 25% order inflow growth.

We believe the company is also comfortably placed to meet its FY11 inflow guidance of Rs87bn

(up 25% yoy), given order inflows of Rs360bn in 1H11 (up 29% yoy).

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Chart 1 : Order book & inflow (Rs m)

0

200,000

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1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11

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200,000

250,000

300,000

Order backlog (LHS) Order intake


Revenues were lower-than-expected in 1Q11 but picked up in 2Q11 reflecting the nature of the

business. We expect revenues to pick up further in 2H11 and the company to largely meet its

FY11 revenue guidance. However, we expect margins to contract by about 100bp in 2H11 on a

yoy basis, as metal prices rise.

Chart 2 : Margin movement bound by material costs

0%

2%

4%

6%

8%

10%

12%

14%

16%

1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11

70%

71%

72%

73%

74%

75%

76%

77%

78%

EBITDA Margin RM/net sales (R.H.S)

Source: Company data, RBS forecasts

E&C segment clocks in strong performance

The core E&C segment of the company registered revenues of Rs80.2bn (up 16.9% yoy).

Segment margins also improved during the quarter with PBIT margins coming in at 11.2% (up

110bp yoy) due to better sales mix. However, overall margins were subdued due to decline in

PBIT margin in other segments.

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Table 2 : 2Q11 and 1H11 segmental performance

Rsm 2Q11 2Q11 yoy 1H11 1H10 yoy

Revenues

E&C 80150 68578 16.9% 146589 134307 9.1%

E&E 6724 7077 -5.0% 14175 12835 10.4%

Machinery & Ind products 6981 5096 37.0% 12463 9465 31.7%

Others 1597 921 73.3% 2817 1693 66.5%

Total 95453 81671 16.9% 176044 158300 11.2%Less Intersegment 1331 1759 -24.3% 2291 3623 -36.8%

Net Segment Revenues 94122 79913 17.8% 173754 154677 12.3%

Segment PBIT

E&C 9002 6939 29.7% 17169 13931 23.2%

E&E 868 1060 -18.1% 1606 1740 -7.7%


Others 172 176 -2.2% 507 218 132.6%

Total 11198 9103 23.0% 21567 17770 21.4%

Less: Net Interest 1901 1310 45.1% 3324 2406 38.2%

Unallocable Income 1438 825 74.3% 2317 12052 -80.8%

Others 0 108 -100.0% 52 193 -73.2%

PBT 10735 8511 26.1% 20508 27223 -24.7%

Capital Employed

E&C 73342 71078 3.2% 73342 71078 3.2%

E&E 11571 11301 2.4% 11571 11301 2.4%


Others 2228 1680 32.6% 2228 1680 32.6%

Total 89864 85993 4.5% 89864 85993 4.5%

Unallocable Capital Employed 187628 132307 41.8% 187628 132307 41.8%

Total Capital Employed 277492 218300 27.1% 277492 218300 27.1%

PBIT Margins

E&C 11.2% 10.1% 111bp 11.7% 10.4% 134bp

E&E 12.9% 15.0% -206bp 11.3% 13.6% -223bp

Machinery & Ind products 16.6% 18.2% -166bp 18.3% 19.9% -154bpOthers 10.8% 19.1% -832bp 18.0% 12.9% 512bp

Total 11.7% 11.1% 59bp 12.3% 11.2% 103bp


We maintain our Hold rating with a TP of Rs1,928 (up from Rs1,912)

We maintain our Hold rating on the company. Our target price moves from Rs1,912 to Rs1,928 as

we roll forward our DCF analysis. We have valued the core engineering business based on DCF,

with a cost of equity of 13% and overall weighed cost of capital of 11%. This takes the core

engineering divisions valuation to Rs1,730 (from Rs1,715).

We have updated our valuations for L&Ts subsidiaries as per the latest balance sheet. We value

L&T IDPL at 1.5x total equity invested, which we believe is fair as some of its projects have

started generating cash flows and the pipeline of projects is strong. We continue to value InfoTech

at 11x FY11F PE based on the average valuation for mid-tier Indian IT companies under our

coverage. We also continue to value L&T Finance at 1.5x FY11F P/B, given its average RoE of

15% for the past four years and the fact that it has strong growth plans.

Table 3 : SOTP valuations for L*&T

Particulars Valuation Basis Value

L&T core engg business DCF valuation 1730

L&T Infotech 11x FY11 earnings 58

LT Finance At 1.5x Adj. BV 28

LT IDPL At 1.5xTotal equity invested(as of Sep 10) 85

Other subsidiaries At 1.5x P/BV 27

Target Price 1928


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Larsen & Toubro | Key Financial Data | 18 October 2010

Income statement

Rsm FY09A FY10A FY11F FY12F FY13F

Revenue 339385 370348 441052 574164 647631

Cost of sales -260005 -283705 -337621 -447208 -494650

Operating costs -40158 -38487 -46323 -55588 -66705

EBITDA 39222 48156 57108 71368 86276

DDA & Impairment (ex gw) -3060 -4146 -4985 -5915 -6845

EBITA 36162 44010 52123 65453 79432

Goodwill (amort/impaired) n/a n/a n/a n/a n/a

EBIT 36162 44010 52123 65453 79432

Net interest -4156 -5053 -6761 -6526 -6796

Associates (pre-tax) n/a n/a n/a n/a n/a

Forex gain / (loss) n/a n/a n/a n/a n/a

Exceptionals (pre-tax) 7747 12504 708.4 0.00 0.00

Other pre-tax items 7376 8703 10751 11276 12793

Reported PTP 47129 60164 56822 70204 85429

Taxation -12312 -16409 -17956 -21061 -25629

Minority interests n/a n/a n/a n/a n/a

Exceptionals (post-tax) n/a n/a 708.4 0.00 0.00

Other post-tax items 0.00 0.00 0.00 0.00 0.00

Reported net profit 34817 43755 39574 49142 59800

Normalised Items Excl. GW 7747 12504 1417 0.00 0.00

Normalised net profit 27070 31251 38157 49142 59800

Source: Company data, RBS forecasts year to Mar

Balance sheet


Cash & market secs (1) 56550 93964 105423 110551 137240

Other current assets 215491 249297 300406 391922 440718

Tangible fixed assets 50538 62231 71946 80731 88586

Intang assets (incl gw) 1408 1427 1727 2027 2327

Oth non-curr assets 37710 60527 70527 80527 90528

Total assets 361697 467446 550029 665758 759399

Short term debt (2) 54537 58451 61451 64451 67452

Trade & oth current liab 147762 190545 224910 293210 328862

Long term debt (3) 11024 9557 9557 9557 9557

Oth non-current liab 23778 25776 41797 47732 55741Total liabilities 237100 284330 337715 414950 461613

Total equity (incl min) 124597 183116 212314 250808 297787

Total liab & sh equity 361697 467446 550029 665758 759399

Net debt 9011 -25956 -34415 -36543 -60231

Source: Company data, RBS forecasts year ended Mar

Cash flow statement


EBITDA 39222 48156 57108 71368 86276

Change in working capital -31651 11434 -756.9 -17315 -5168

Net interest (pd) / rec 4156 5053 6761 6526 6796

Taxes paid -12312 -16409 -17956 -21061 -25629

Other oper cash items 3220 3650 3991 4750 5997Cash flow from ops (1) 2634 51885 49146 44268 68273

Capex (2) -18552 -15858 -15000 -15000 -15000

Disposals/(acquisitions) 0.00 0.00 0.00 0.00 0.00

Other investing cash flow -5769 -41620 -9258 -9966 -9967

Cash flow from invest (3) -24321 -57478 -24258 -24966 -24967

Incr / (decr) in equity 586.7 33.0 0.00 0.00 n/a

Incr / (decr) in debt 29721 2448 3000 3000 3001

Ordinary dividend paid n/a n/a n/a n/a n/a

Preferred dividends (4) n/a n/a n/a n/a n/a

Other financing cash flow -10513 9678 -16428 -17174 -19617

Cash flow from fin (5) 19795 12159 -13428 -14174 -16616

Forex & disc ops (6) n/a n/a n/a n/a n/a

Inc/(decr) cash (1+3+5+6) -1892 6566 11459 5127 26689

Equity FCF (1+2+4) -15917 36027 34146 29268 53273

Lines in bold can be derived from the immediately preceding lines.Source: Company data, RBS forecasts

year to Mar

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Larsen & Toubro | Performance and Valuation | 18 October 2010

Standard ratios Larsen & Toubro Bharat Heavy Electricals Voltas

Performance FY09A FY10A FY11F FY12F FY13F FY11F FY12F FY13F FY11F FY12F FY13F

Sales growth (%) 35.7 9.12 19.1 30.2 12.8 25.9 16.5 10.1 16.2 16.5 16.2

EBITDA growth (%) 32.1 22.8 18.6 25.0 20.9 32.9 16.0 7.46 1.11 14.8 18.3

EBIT growth (%) 31.1 21.7 18.4 25.6 21.4 35.3 16.2 7.28 0.53 14.9 18.7

Normalised EPS growth (%) 34.3 14.6 22.1 28.8 21.7 34.1 16.9 12.9 -2.23 14.2 17.7

EBITDA margin (%) 11.6 13.0 12.9 12.4 13.3 20.1 20.0 19.5 8.31 8.18 8.33

EBIT margin (%) 10.7 11.9 11.8 11.4 12.3 19.0 18.9 18.4 7.88 7.77 7.94

Net profit margin (%) 7.98 8.44 8.65 8.56 9.23 14.0 14.0 14.4 6.29 6.16 6.24Return on avg assets (%) 9.44 8.35 8.39 8.80 9.03 10.8 10.4 9.93 9.55 9.05 9.05

Return on avg equity (%) 24.6 20.3 19.3 21.2 21.8 31.7 29.0 26.1 28.6 26.3 25.3

ROIC (%) 29.8 21.4 21.7 24.1 24.4 86.0 72.4 73.9 66.1 48.0 47.1

ROIC - WACC (%) 19.1 10.7 11.0 13.5 13.7 74.9 61.3 62.7 54.8 36.6 35.7

year to Mar year to Mar year to Mar

Valuation

EV/sales (x) 3.56 3.16 2.64 2.02 1.76 2.71 2.21 1.90 1.33 1.13 0.95

EV/EBITDA (x) 30.8 24.3 20.4 16.3 13.2 13.5 11.1 9.74 16.0 13.8 11.4

EV/EBITDA @ tgt price (x) 29.8 23.6 19.7 15.8 12.8 16.2 13.4 11.9 11.1 9.52 7.82

EV/EBIT (x) 33.4 26.6 22.3 17.7 14.3 14.3 11.7 10.3 16.9 14.5 12.0

EV/invested capital (x) 8.75 7.27 6.40 5.32 4.71 8.91 8.07 7.10 7.04 5.76 4.77

Price/book value (x) 9.56 6.55 5.65 4.78 4.03 6.01 4.74 3.83 5.66 4.62 3.78

Equity FCF yield (%) -1.34 3.00 2.85 2.44 4.44 2.23 4.28 4.49 1.16 3.76 4.50

Normalised PE (x) 44.0 38.4 31.4 24.4 20.1 21.4 18.3 16.2 22.1 19.3 16.4

Norm PE @tgt price (x) 42.7 37.2 30.5 23.7 19.4 25.2 21.6 19.1 15.6 13.7 11.6

Dividend yield (%) 0.51 0.63 0.70 0.78 0.93 0.79 0.87 0.95 0.94 1.02 1.07year to Mar year to Mar year to Mar

Per share data FY09A FY10A FY11F FY12F FY13F Solvency FY09A FY10A FY11F FY12F FY13F

Tot adj dil sh, ave (m) 598.9 603.2 603.2 603.2 603.2 Net debt to equity (%) 7.23 -14.2 -16.2 -14.6 -20.2

Reported EPS (INR) 58.1 72.5 65.6 81.5 99.1 Net debt to tot ass (%) 2.49 -5.55 -6.26 -5.49 -7.93

Normalised EPS (INR) 45.2 51.8 63.3 81.5 99.1 Net debt to EBITDA 0.23 -0.54 -0.60 -0.51 -0.70

Dividend per share (INR) 10.2 12.5 14.0 15.4 18.6 Current ratio (x) 1.34 1.38 1.42 1.40 1.46

Equity FCF per share (INR) -26.6 59.7 56.6 48.5 88.3 Operating CF int cov (x) -2.60 -12.5 -8.93 -9.01 -12.8

Book value per sh (INR) 208.0 303.6 352.0 415.8 493.7 Dividend cover (x) 3.78 3.15 3.95 3.57 4.47

year to Mar year to Mar

Priced as follows: LART.BO - Rs1988.60; BHEL.BO - Rs2524.85; VOLT.BO - Rs234.55Source: Company data, RBS forecasts

Valuation methodology - SOTP valuations for L*&T

Particulars Valuation Basis Value

L&T core engg business DCF valuation 1730

L&T Infotech 11x FY11 earnings 58

LT Finance At 1.5x Adj. BV 28

LT IDPL At 1.5xTotal equity invested(as of Sep 10) 85

Other subsidiaries At 1.5x P/BV 27

Target Price 1928


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Larsen & Toubro | Strategic and Competitive Overview | 18 October 2010

Strategic analysis Average SWOT company score: 3 Shareholding pattern

Company description Hold Price relative to country

Larsen & Toubro (L&T) is the largest engineering and construction conglomerate in India. The company also has

business interests in electrical equipment, construction equipment, information technology, defence equipment

and equipment leasing. Until FY04, L&T was the largest manufacturer of cement in India, before it sold off its

cement business to Grasim Industries. Recently, L&T partnered with global power equipment major Mitsubishi

Heavy to manufacture main plant power-generation equipment with supercritical technology. L&T derives business

mainly from capex in infrastructure and industry.

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Sep08

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Price relative to country

Competitive position Average competitive score: 2+ Broker recommendations

Domestic

Institution

37%

Non -

Institution

42%

FIIs

17%

Custodians

4%

Source: Bombay Stock Exchange

Market data

HeadquartersLarsen & Toubro Ltd, L&T House, BallardEstate, Mumbai - 400001, India

Websitewww.larsentoubro.com

Shares in issue602.2m

Freefloat

100%

Majority shareholdersLife Insurance Corporation of India (19%), L&TEmployee Welfare Trust (12%), UTI MF (9%)

Supplier power 3-RM suppliers have a negligible impact on the company. However, L&T is exposed to increases in the prices of keyraw materials such as steel, cement, etc.

Barriers to entry 4+

High, as the project nature of business calls for experience in diverse end-user sectors and strong execution skills.

Customer power 1+

Emergence of newer companies has given customers more choice. However, for specific projects, customers may

have to turn to L&T.

Substitute products 2+

There are substitutes in individual sectors, such as power, construction etc, but none with experience as diverse

as L&T's.

Rivalry 1-

Larsen & Toubro does face some rivalry. Rivals in individual sectors include BHEL in power, HCC in construction

etc.

Scoring range 1-5 (high score is good) Plus = getting better Minus = getting worse

Country view: India Country rel to Asia Pacific

The macro picture for India has been constructive recently, with GDP and industrial production tracking in line with

expectations, while portfolio allocators continue to favour the market for its domestic consumption orientation.

However, these positives have already been priced in and we believe risks are rising from the increasing double

deficit, demanding valuations and tightening liquidity.

The country view is set in consultation with the relevant company analyst but is th e ultimate responsibility of the Strategy Team.

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MarketIndex

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Buy Hold Sell

Source: Bloomberg

Strengths 4

Dominant player in India's non-power engineering and construction businesses, with a diversified customer base.

Experienced in handling large projects and has superior project-execution skills.

Weaknesses 2

The company is predominantly a domestic play, but it needs to expand its foothold in global EPC projects.

Opportunities 5

The thrust by the Government of India in terms of infrastructure development provides new opportunities for the

company, such as turnkey solutions. Rising oil prices open capex opportunities in refining and infrastructureconstruction projects in Gulf countries.

Threats 1

Any slowdown in infrastructure development and the investment upcycle would likely hamper the company. Any

adverse change in government policies would also likely have an effect.

Scoring range is 1-5 (high score is good)

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Larsen & Toubro | Disclosures Appendix | 18 October 2010

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