Analyst Corner: Retain ‘buy’ on Larsen & Toubro with target price of Rs 1,540

We hosted top inflow likely in Q3.  We expect the capex outlook to improve as government revenue collection comes back to pre COVID-19 run rates. Increase TP to INR1,540 (from INR1,160) to factor in a faster revival and return to normalcy with fresh reforms; retain Buy. Laggard could become the front runner. Shares of L&T have under-performed Nifty not just in the previous year, but in many of the last 5 years as 2014 expectations of a revival in infrastructure remained elusive.

L&Tis now much more diversified, and we estimate c 40% of EBIT and c50% of the stock price from the services sector. The stock now trades at 18x FY22e EPS, which is towards the low end of its 2015-2019 trading range of 15x-31x. Adjusted for subsidiary valuation (10% discount), the core business now trades at only 11x FY22e PE despite being a very diversified, decent growth (c8-10%), and strong ROCE business (c17-18%). We believe CY21 will likely mark a year where both its services business (IT and financial services) and its project infrastructure business will see growth.

Capex outlook likely to improve with improving government finances: Despite tight finances, the government has not shirked from announcing and going ahead with large projects like high-speed rail and large tunnel or road projects. We believe this is a clear signal of the government’s intent and the support that it is getting from multi-lateral agencies in funding large projects.

We are now seeing an improvement in the economy and government efforts to plugging tax leakage are showing up in its tax collections. The capex plans for Publics Sector Undertakings (PSUs) have largely remained unaffected by COVID-19. State finances driven by petroleum product taxes and real estate revenue should also see improvement. Further, lower interest rates, government-led incentives, and recovery in demand should pave the way for a selective private capex recovery on a benign base.

With finances improving,we expect new order momentum to continue next year. We also incorporate the increased share prices of listed subsidiaries and roll over our valuation base. We increase our target price to INR1,540 (from INR1,160). Downside risks include slower pickup in the corporate capex cycle; slower-than-expected recovery in execution; cancellation of orders.