Larsen and Toubro Ltd’s (L&T) shares surged immediately after the company’s results for the March quarter were announced, despite the shortfall in revenue and net profit when compared with consensus estimates.
The markets cheered L&T’s performance on several counts. Firstly, March quarter order inflows at Rs30,400 crore beat estimates and were 27% higher than a year before. The total order book stood at Rs1.3 trillion as of March-end. More importantly, it bucked the pessimistic macroeconomic forecast of subdued investment demand. Weak order inflows in the preceding two quarters had led to questions about future contracts and were a reason why the stock underperformed the benchmark Sensex.
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Secondly, L&T’s management has reaffirmed its ability to maintain 15-20% growth in order inflows during fiscal 2012 (FY12). Its existing order book is expected to translate into 25% growth in revenue on the back of strong execution.
Thirdly, contrary to expectations of a moderation in profit margins, L&T maintained its operating margin during the quarter at 15.5% compared with year-ago levels, even as it rose 440 basis points from the preceding quarter. One basis point is one-hunderdth of a percentage point.
While rising material costs have hit profitability of most infrastructure and engineering firms, L&T was able to reduce its percentage of raw materials to sales during the quarter. Operating leverage, price-escalation clause built into orders given its size and credibility, and cost-control helped. In fact, its counterpart, Bharat Heavy Electricals Ltd, too, showed a year-on-year (y-o-y) reduction in this parameter citing similar reasons. But strong competition in tender-driven orders could see pricing pressures and temper margins in the medium term.
A segment-wise analysis, too, surprised the Street. The March quarter showed improved profitability from the electrical and electronics segment, which was languishing in the previous two quarters. Being largely product-driven, the segment benefited from price escalations taken in the preceding quarter. A change in accounting practice, too, shored up margins.
In fact, L&T’s largest revenue segment—engineering and construction—registered a marginal drop in profitability. The machinery and industrial division posted strong revenue and profit growth due to strong demand from mining and construction, valves and rubber products. On the whole, L&T’s 9% y-o-y growth in net profit (after adjusting for gains from a stake sale) during the quarter was marginally lower than estimates.
L&T also contained interest costs as a percentage of sales in the March quarter. “Effective interest rate for the firm rose to 8% in FY11 from 7% in FY10. But we expect the rate hikes to cool off in the second half of FY12,” said R. Shankar Raman, senior vice-president (finance and legal) at L&T.
Nevertheless, if inflationary pressures continue beyond the next two quarters and interest rates rise accordingly, they could hurt the capital expenditure plans of private sector firms, which constitute a large chunk of L&T’s clientele. But the strong pace of execution could take care of valuations—the stock trades at a reasonable 16-17 times one-year forward earnings.
Graphic by Yogesh Kumar/Mint
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