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We reiterate ‘reduce’ rating on Larsen & Toubro (L&T) on full valuations even as risks of margin and large consolidated debt remain pertinent. Given the low RoE of the Hyderabad Metro project and traffic disappointments in the road projects, we believe 1x price-to-book (P/B) value for Larsen & Toubro’s development portfolio seems reasonable. We retain our estimates of Rs 48.2 and Rs 58 for FY14 and FY15, respectively, and our target price of Rs 970.
The Hyderabad Metro project is one of the largest global PPP development projects with a total project cost of Rs 16,400 crore (funded by Rs 4,500 crore equity, Rs 10,400 crore debt and Rs 1400 crore grant) with a concession period of 35 years (extendable by 25 years). The project involves development of three Metro rail corridors across 71 km with 66 stations and 18.5 million sqft of real estate development. The project forms accounts for about a quarter of the project cost of L&T’s development portfolio.
We have attempted to arrive at a prima facie valuation for L&T’s Hyderabad Metro. The project may potentially have a sub-optimal equity IRR of 12% (with a negative NPV of R670 crore) against potential equity investment of Rs 4,600 crore. However, we note this is a preliminary and elementary valuation and has not benefitted from L&T’s perspective. The L&T management, at a recent meeting, sounded confident of the project in terms of construction progress and financial viability.