Stock Recommendations:: Larsen & Toubro, Mahindra & Mahindra (L&T, M&M)

Larsen & Toubro
Recommendation: Buy
Price target: Rs4,044
Current market price: Rs2,882

Performance beats expectations

Result highlights

• The Q4FY2008 results of Larsen and Toubro (L&T) are ahead of our expectations on both top line and profitability fronts.
• The stand-alone top line saw a strong growth of 35.5% to Rs8,466.9 crore, ahead of our expectations. The growth was primarily driven by the stellar performance of the engineering and construction (E&C) division, which grew by 38.2%.
• The operating profit margin (OPM) improved by 20 basis points year on year (yoy) and by 250 basis points sequentially to 13.2%. Looking at the segmentals, the E&C division reported an excellent margin growth as the earnings before interest and tax (EBIT) margin improved by 130 basis points yoy to 15%. Consequently, the overall operating profit grew by 38.1% to Rs1,118.1 crore.
• A higher other income and a stable depreciation charge led to a 25.5% growth in the adjusted profit. The reported profit rose by 38% to Rs966.8 crore after taking into account an exceptional item of Rs87.23 crore relating to the gain on the sale of a stake in a group company.
• L&T has also decided to issue bonus shares in the ratio of 1:1 subject to the approval of the shareholders.
• The management maintains its bullish outlook and stands by its earlier guidance of maintaining a 30-35% top line growth in the next couple of years. The demand scenario remains bullish and the company is hopeful of maintaining its margins going forward as well.
• We have realigned our consolidated earnings per share (EPS) for FY2009 and FY2010 to factor in the performance of the key subsidiaries and the company's (L&T) stake sale in the RMC business and in HPL Cogen. Our revised EPS for FY2009E and FY2010E stands at Rs110.5 and Rs150.1 per share respectively.
• L&T's sound execution track record and strong order book position as well as the excellent performance of its subsidiaries enforce our faith in the company. We value the core business of L&T at 25x FY2010E earnings, or Rs3,038 per share. We value the subsidiaries at Rs1,006 per share of L&T. At the current market price of Rs2,882, the stock is trading at 19.2x its FY2010E consolidated earnings. We recommend a Buy on the stock with our sum-of-the-parts based price target of Rs4,044.

Mahindra & Mahindra
Recommendation: Buy
Price target: Rs800
Current market price: Rs606

Price target revised to Rs800

Result highlights

• The Q4FY2008 results of Mahindra and Mahindra (M&M) are slightly below our expectations due to higher tax expenses incurred during the quarter.
• The stand-alone net sales grew by 14.6% year on year (yoy) to Rs3,148 crore in Q4FY2008. The operating profit margin (OPM) for the quarter declined by 50 basis points to 10.9% yoy. A lower other income, and higher interest cost and income tax resulted in a 16% decline in the pre-exceptional profit after tax (PAT) to Rs207 crore. The company realised a net extraordinary income of Rs14 crore on account of the profit arising from the merger of certain subsidiaries with it and the expenses on a voluntary retirement scheme. Thanks to this, the reported PAT declined by only 13.4% to Rs221 crore from Rs255 crore in Q4FY2007.
• On a stand-alone basis, the net sales for FY2008 grew by 14.7% to Rs11,503 crore. The operating profit rose by 8.3% to Rs1,336 crore. The adjusted PAT grew by 10.4% to Rs 938.2 crore whereas the reported PAT grew by 14.9% to Rs1,103.4 crore.
• On a consolidated basis, the net sales for FY2008 grew by 35.2% to Rs23,775 crore. The OPM declined from 15.5% in FY2007 to 13.9% in FY2008. Consequently, the operating profit grew by only 21.6% to Rs3,308 crore. The PAT after minority interest grew by 6% to Rs1,573 crore.
• The company has increased its capital expenditure (capex) outlay and plans to spend approximately Rs2,000 crore per year for the next three years. The funds would be utilised for setting up the new plant at Chakan, carrying out capacity expansions at the other plants, launching new products and carrying out research and development (R&D) activities.
• We expect FY2009 to be a year of challenges for the company as during this period its sales are likely to be affected by the caution being exercised by financiers in extending credit on account of the rising delinquencies in the automotive and tractor businesses. In addition, the margins are expected to be under pressure on account of the rising commodity prices. The management hopes to cope with these challenges with its continued focus on cost control, process efficiencies and product innovations that exceed customer expectations.
• We continue to value M&M on the sum-of-the-parts (SOTP) method and at the current market price of Rs606, the stock discounts its standalone FY2010 earnings by 15.8x. We maintain our Buy recommendation on the stock with a revised price target of Rs800.