L&T - Bluechip, Value play, Digital giant in making

Stock Opportunities
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I am surprised that we don’t have a thread on Infra companies.

L&T needs no introduction being most formidable infra company.

What has gone unnoticed is that remarkable transformation company has been undergoing and continues to evolve as we talk.

Currently company broadly operates into following areas:

  • EPC: Largest segment
  • IT and Digital: LTTS, LTI, Mindtree and L&TNxt
  • Defence manufacturing
  • Finance - L&T Finance
  • SPV and BOT Assets: Like Hyderabad Metro, Punjab Power plant etc. L&T intends to exit this segment
  • Engineering goods - Almost out of this segment with sale of electrical and automation business to Schneider

L&T intends to focus on first three segment which has huge potential with intention of being a global player. It has scale and proven capability for the same.

Market seems to be ignoring this digital giant in making despite companies intentions. Let us look at it from valuations perspective:
Total MCap: 126k cr

L&T Infotech (74%) valuation share: 42k cr
Mindtree (61%) valuation share: 16k cr
L&T Tech Services (61%) valuation share: 14k cr
Total Digital/tech listed valuation share: 72k cr which is 57% of mcap

Add to this L&TNxt is being incubated as leading Industry 4 and IoT play.

So, Total Digital/Tech play is 57% of MCap + L&T Next. And these of leading edge Digital/Tech play unlike IT services companies which has legacy services and BPO components.

L&T Infotech is likely to be merged with Mindtree leading to synergies.

Intention was made clear with Mindtree acquisition. They are already sitting on huge cap gains at current prices.

L&T Tech services will likely be paired with L&T Nxt after it reaches critical mass.

This is all falling in place.

Now coming to total valuations:

L&T Finance 64% stake: 8k cr

So total valuation of listed entities is 80k crore out of 126k Mcap.

This is contributes to Rs 570 out of Rs 900 share price currently.

Next financial year should see normalization of Infra project execution and with average performance standalone entity should do an EPS of 50.

Assuming a conservative PE of 16. Core business should be valued around Rs 800.

Add to this valuation of SPV which is valued between 30-100. Taking lower value of 30.

We get a valuation of Rs 1400.

Upside to above valuations:

  1. Better order book: Their order book has picked up off late and impact due to corona has been negligible. They are already winning as much orders as they are executing. Government thurst on infra is likely to be back.
  2. Acceleration to digital play execution and market recognition.
  3. Government push to defence manufacturing. They are one of two shortlisted play along with Mazgaon Dock for 45k crore submarine project. L&T is said to get at least 50% of the project as Mazgaon is already running behind due to previous orders. Talks a lot about defence capability. Will catapult it into global play.

Disc: Invest around 900+

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We do have one on NCC :slight_smile:

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This is contributes to Rs 570 out of Rs 900 share price currently.

@ nav_1996, Thanks for the detailed calculation. I would like to add one point to the above.

Shouldn’t we need to apply the holding company discount to Rs: 570? Currently many holding companies are trading at around 50~60% discount. So if we apply 60% discount to Rs:570 then the total value comes to Rs:1058 (using your calculated value).

Disclosure: I do hold L&T at an average ~Rs:1100.

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As they hold majority stake in each company and EPS is consolidated with parent I am not applying holdco discount.

For Reliance is market applying Holdco discount for Jio and retail. I think no.

I have noticed that analysts start applying Holdco discount when sector is out of favour and it disappears when sector is back in favour.

I guess holdco discount makes sense only when it is minority/investment holding.

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For RIL, there is no significant holding discount as its subsidiaries are not listed yet. Generally, whenever the subsidiaries are listed and investors have option to directly invest in them, the holding company discount comes into picture. For, if I am interested in the digital game of L&T, I would in all probability, try to invest in an LTI and LTTS while I dont have that option for Jio yet. Thanks

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Thanks for your views.

I have slightly different perspective. I don’t see how economic value of parent company changes if it owns 75% of a subsidiary whether it is listed or not.

Infact if a subsidiary is not listed, there is no market value discovery and has higher risks to valuations. Look at differential in Airtel and projected Jio valuations by PE investors, which may or not not sustain after listing.

Yes a demand and supply can distort valuations in short term.

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I have another viewpoint on the holding company discount. The holding company can only benefit with the cashflow from the subsidiary via dividends or any business arrangement which they may have (like loans transferred between HDFC ltd & HDFC bank for a consideration).

It is expected that the holding company will never ever sell off their holding in the markets at the market valuations to distribute the proceedings to the shareholders so it’s fair to not consider it at market value in SOTP valuation of holding company. This holding company discount can vary depending on market conditions & company in view. like Bombay Burmah Trading Company (BBTC) holding Brittania, HDFC ltd holding many HDFC group companies, Bajaj holding company holding other Bajaj companies, Tata Sons holding so many tata group companies, so on & so forth.

So we should consider the stakes of LTI, LTTS, L&T fin, etc at a discount while doing a SOTP valuation of L&T.

Hope it helps understand better, Please highlight of there is any gap in my understanding.

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Holding company discount varies from year to year and sector to sector. It is in the range of 45 to 70 percent during the last five years. Currently holding company discount is highest for real estate sector at 80 per cent and the least in chemical sector with 18 per cent as per this study. Market may reward Holding company with declining discount in case of the subsidiaries with good growth and profitability. Long term investors can reap benefits of declining holding company discounts if they can identify holding companies which can keep their subsidiaries in a profitable projectile. Avoiding holding company discount in valuations will lead to wrong valuations and confirmation bias.

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Thanks. But please note that L&T is not a classical holding company. It is multi-billion dollar operating biz on stand alone basis. It is like HDFC or Reliance.

Even if we apply 20% holdco discount to subsidiaries. We get a valuation of around Rs 1300.

Other way is look at consolidated EPS which should be in range of Rs 66-70. Applying a higher blended PE of 20 (Infra + Digital), we get a similar valuation of Rs 1300-1400.

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So analysts have started recognizing value of digital businesses and it is just a matter of time before perception also changes as soon as macro improves in a couple of Qs.

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Hope submarine deal contract is also awarded this year

Business transformation on track with sell of non-core assets

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This is called sector bias or sector being out of fashion. This is where value investors fish.

Added to this L&T Tech Svcs and L&T Infotech results have been pretty good.

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Special dividend likely. Record date 5th Nov

https://www.bseindia.com/corporates/anndet_new.aspx?newsid=dd48be5b-51cb-4dc2-a13b-5ccd1c881814

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CRISIL reaffirms ratings for L&T

https://www.crisil.com/mnt/winshare/Ratings/RatingList/RatingDocs/Larsen_and_Toubro_Limited_October_23_2020_RR.html

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Shows that L&T is only private sector entity which has muscle to build defence ships and submarines.
Order likely to got to PSU and L&T

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Kotak has increased 12 month target to 1300 recognizing obvious triggers.

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Their dividend was really poor considering they will be investing some part of the new funds into non core business as well. Overall, the distribution of funds might be just okay but the kickstart for the investors could have been made sweeter with a higher dividend at least for the short term as sympathized by several other analysts too.

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Another billion dollar win