L&T is the best bet among beaten-down large caps

Rising debt of subsidiaries and losses may push up company's debt over time

The recent carnage in the market has spared few large cap stocks, which is why everyone is asking if it is time to buy these fallen angels. Larsen & Toubro (L&T's) is one such fallen angel as the stock has fallen by 26 per cent since June this year. At these levels, L&T's core business is valued at 10x its FY14's earnings (stress case). Going by current valuations and the potential of a possible rebound some quarters down the line, L&T has a 'buy' call from most analysts. The stock had plunged to similar levels in December 2011 and rebounded from there.

At these valuations, the market is factoring in zero order inflows in FY15, fall in margins by 180 basis points and higher working capital stress. Also, the current stock price also seems to suggest that the company may miss its revenue and order inflow guidance in FY14. Macquarie Capital Securities has a worst case valuation of Rs 715 a share for the company based on discounted cash flows.

Given the bleak macro-economic environment and drying up of new orders, L&T could be in for a lot more pain. Though the company's revenues grew by five per cent in the first quarter, the company has not changed its guidance and believes it will meet its targeted 15 per cent guidance. There is better clarity on the order inflows front, as analysts believe the company is set to win orders of Rs 50,000 crore in the first six months of the year, 50 per cent of its target. The second half is typically better for order inflows. The company has also maintained that its margins will in the engineering and construction segment will not be hit. Execution of projects could come under stress due to tighter liquidity conditions and a ban on sand mining. Macquarie believes it is too early to factor in such risks, even though the market seems to be pricing in a miss in guidance.

What worries analysts is not the standalone business but the subsidiaries. The subsidiaries of L&T are a concern as they require investments by the parent. Espirito Santo's Aditya Bhartia is of the opinion that the estimated consolidated earnings per share (EPS) for FY14 could be lower than standalone for a variety of reasons. For starters, investments by the parent company into subsidiaries should expand to Rs 2,000-3,100 crore annually (versus Rs 1,100 crore in FY13), with some subsidiaries requiring short-term loans to fund cash losses/meet debt repayment obligations.

Analysts also expect the company's consolidated debt to rise by over 60 per cent over the next three years. However, there is no risk of a balance-sheet stress. Bhartia says: "We believe L&T will emerge stronger from the downturn, with an improved competitive position and a larger addressable market (increased focus on international markets)."