Larsen & Toubro: An engineering behemoth

Infrastructure is key to any economy's growth companies involved in the sector are effectively building a nation. And in India, Larsen & Toubro (L&T) is one of the most important of these nation builders.

The company has been involved in providing India with infrastructure, heavy engineering equipment, and power plant equipment for the last seven decades. It provides transportation infrastructure (roads, railways, ports and airports), water infrastructure, and urban building infrastructure (hospitality, educational and healthcare facilities).

On the engineering side, L&T makes heavy industrial and defence equipment, and provides an entire range of power plant construction services. It also has stakes in hydrocarbons, information technology and financial services.

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At the end of its 2011/12 financial year, the company's 1.4 trillion rupee order backlog looked like this: roughly 43% of orders were for infrastructure projects, 28% for power, and 10% from hydrocarbons.

The future of Indian infrastructure and engineering

India's infrastructure development is gradually gathering pace. There are plenty of opportunities for improvement. Transport infrastructure remains under-developed. Given India's public sector deficit, the government is trying to address this through private sector participation. Private public partnerships (PPP) are one solution, which throw up huge opportunities for infrastructure companies, be it roads, ports or airports.

Considering that India is an agrarian economy, water infrastructure projects also offer huge growth potential. Also, with urbanisation still increasing rapidly, activity in the urban infrastructure segment is also likely to remain buoyant.

On the engineering side, India needs more power. So companies engaged in making power generation equipment have huge potential. On this front, L&T has a wide power portfolio comprising boilers, turbines and generators.

Its presence in the power transmission and distribution side is an added benefit. That's because India's back-end power infrastructure is still in its nascent stages. Apart from this, defence and hydrocarbons (upstream and downstream) also offer lucrative opportunities.

The problems facing the sector

The high cost of capital and political paralysis are the main challenges faced by the industry. Given high inflation, the Reserve Bank of India (RBI) has adopted a hawkish monetary stance. Although there were rate cuts recently, the current interest rate environment is still not attractive for corporates. Due to the higher cost of capital, spending on new equipment is being delayed. For this to improve, the interest rate cycle needs to become more favourable.

On the policy side, indecisiveness is a real problem. Projects are being delayed by environmental and land acquisition issues, while red tape has been another hindrance.

Both factors have hit order pipelines in the sector, putting top-line growth under threat. Volatility in commodity prices has also affected the margins of the companies with a higher percentage of fixed orders in their basket.

However, it should be noted that the current issues faced by the industry are cyclical, not structural. Once inflation cools down, interest rates will fall and capital investment will gather momentum. Also, the current bureaucratic issues will probably be ironed out over the medium to long-term.

Should L&T be a part of your stock portfolio?

Given its diversified portfolio, L&T is a great play on India's infrastructure story. It remains immune to a slowdown in any one sector, while its international presence and exposure to finance and IT make the company's business model resilient. So while this is a cyclical industry, L&T is one of the gems in the sector that will not come cheap.

By Equitymaster India's leading independent equity research initiative. Trusted by over a million members all over the world, Equitymaster, with its well-researched, unbiased and honest opinions is the preferred destination for investors interested in investing in India.