Larsen & Toubro is one of the heavy weight company on the index and as I am writing this article it is almost trading up by 9% in the market. Let us have a glance on its results and understand is there a real opportunity to make money at these levels by investing in them and how long will it take to reap good returns.

L&T is the India’s thermometer to check how the economy is doing in the country, this is what many economist and analyst say. And they are right in saying as L&T is conglomerate made up of businesses in various sectors which are of interest to any government ruling the nation. There are 9 different sectors they operate and let us have a glance of their weightage and profits they made for the conglomerate in 2016.

  Revenues 2016 Weightage Profits before interest & Taxes Weightage
Infrastructure Rs 50,386.67 crore 48.67% Rs 5,274.05 crore 49.77%
Power Rs 7,010.68 crore 6.77% Rs 580.58 crore 5.48%
Metallurgical & Material Handling Rs 2,836.99 crore 2.74% Rs 40.11 crore 0.38%
Heavy Engineering Rs 3,323.30 crore 3.21% Rs (192.03) crore (1.81%)
Electrical & Automation Rs 5,446.32 crore 5.26% Rs 498.90 crore 4.71%
Hydrocarbon Rs 8,839.78 crore 8.54% Rs (15.43) Crore (0.15%)
IT & Technology services Rs 9,116.62 crore 8.81% Rs 1,698.25 crore 16.03%
Financial services Rs 7,541.16 crore 7.28% Rs 1,028.46 crore 9.71%
Developmental projects Rs 5,146.10 crore 4.97% Rs 621.88 crore 5.87%
Others Rs 7,134.72 crore 6.89% Rs 1,130.08 crore 10.67%
Total Rs 103,522.23 crore   Rs 10,595.99 crore 10.24%

 

Looking at the above table we can definitely tell that Infrastructure segment is the backbone for this conglomerate. We don’t like this business as it fails our standard of expectations about what we admire in the business. Let us not get in detail about it, in our opinion businesses like this cannot exceed its return more than the GDP of the country in the long term.

But we can take the clues from the outlook, as they are into so many sectors and different businesses, the insight about market condition from the management is worthwhile to study further. Here is the paragraph that really picked up my attention.

The domestic market continues to hold promise for revival of growth. Private sector and industrial capex is likely to take time to revive as investment sentiment is weak. Execution conditions remain challenging, mainly due to the limitation of the projects/ clients to raise finances and slower clearances for land and environment. Banking system was stretched in corporate lending.

Though they are not in the banking industry but the outlook for the market especially for the banking sector looks grim for the coming financial year from their comments. Corporate lending by the banks stand around 55% of their entire loan book and if that area of business is under pressure, it will definitely impact negatively to the banking earnings.

Coming to the valuations, let us do this exercise differently then what we normally do. Let us shut down the stock market, and imagine you got this proposal to invest in the L&T business today.

We will do some number crunching here, let us assume you want Rs 1.2 million every year (Rs 100,000 every month) as living expenses and you are looking to invest in the business. L&T reported its EPS for 2016 as Rs 54.69. To earn Rs 1.2 million in 2016 as profits from L&T you will need to buy 21,942 shares in this business. If each share is trading at Rs 1,400 today, then you will need Rs 30,718,800 to buy them to generate Rs 1.2 million in profits.

Let us say you like the proposal and you invested Rs 30.72 million today. The long term earnings are expected to grow by 14% per anum. Fast forward two years, your earnings are sitting at Rs 1.56 million and you feel very happy by investing in this business two years back. But hang on a second, this business also needs cash inflow to keep it profitable. It has to retain 70% of your profits back in to the business to sustain its profitability. So on top of your Rs 30.72 million invested two years back, you had chipped in another Rs 2.05 million of your profits.

So in two years’ time if we calculate your return on investment, for the second year will be 4.76% (1.56/32.77). Today if you are buying the stock on the basis of next year’s earnings your expected return on investment will be 4.46%.

So every year if you remain invested, you might see your ROI climbing in range of 0.30% – 0.50% every year (depending on how profitable they will be in future). If your expected return on investment is 10% then you might have to stay invested at least for the decade in this business to climb your ROI to that level and almost another half a decade to catch up your last decade deficit returns.

There are other businesses in the market that I am aware of available today which will generate more than 10% ROI in two years’ time and will climb up at good rates if you stay invested within them for a longer term you will make really good money. You all are the smart enough to understand by now what I think about the L&T valuations.

Aziz Dodhiya is the chief investment officer for the Valueoperations funds which operates in the Indian market as an FPI (Foreign Portfolio Investor). We do not offer any personal advice to buy or sell any stocks and the views that are shared by Aziz might not incline to your personal investment strategy and this is the reason we advise you to take professional advice before going ahead with our views.