L&T results underscore weakness in domestic investment demand

Domestic order inflows for the June quarter fell 9% y-o-y, this being the fifth consecutive quarter when order inflows have shrunk


The 14% jump in total order inflows in the quarter were mainly from outside India. But this, too, was mainly from one big order in West Asia.
The 14% jump in total order inflows in the quarter were mainly from outside India. But this, too, was mainly from one big order in West Asia.

Performance misses apart, Larsen and Toubro Ltd’s (L&T’s) management commentary following the June quarter results spells caution.

A sluggish domestic economy, rise in input costs and higher provisioning under the new accounting norms were highlighted at its media conference.

Domestic order inflows for the June quarter fell by 9% year-on-year (y-o-y), this being the fifth consecutive quarter when order inflows have shrunk. This trend underscores the weakness in investment demand, given that L&T is the largest play on domestic infrastructure and engineering.

The 14% jump in total order inflows in the quarter were mainly from outside India. But this, too, was mainly from one big order in West Asia.

Analysts say that international orders, especially the recent ones, may lead to stress on profitability.

In any case, stiff competition has led to orders being taken at lower profit margins than in earlier years. This explains L&T’s gradual slide in operating margin over the last three to four years.

Also, a Religare Capital Markets report highlights that past misallocations of capital into areas which failed to meet expectations are unlikely to change in the near future. Some business segments such as hydrocarbons, real estate and shipbuilding have been a drain on L&T’s profitability. The June quarter’s consolidated operating margin of 8.7%, a tad higher than a year ago, was a huge letdown from estimates on the Street.

The new accounting norms are a source of confusion. Under the new rules, costs in the profit and loss account increase due to higher provisioning for expected credit loss due to delay and credit risk, certain employee benefits and valuation of investments. Consolidation of joint venture businesses only at the net profit-level makes it difficult to comprehend sales performance and costs of these businesses. The logic here perhaps is that it is only the return on money invested in the joint venture that is relevant to consolidated accounts. The change in accounting will continue to cause some confusion on y-o-y comparison for the ensuing quarters in this fiscal, too.

That’s not all. Working capital levels are still high at almost a quarter of sales, though the management is not unduly worried on receivables. L&T’s management is confident of meeting its guidance of 15% growth in fresh orders. But will the situation improve on domestic orders this year? The magnitude of impact of the restatement of accounts of the remaining quarters of the corresponding period a year ago will have a bearing on earnings forecast and valuation, too. That’s why the 45.5% growth in net profit during the June quarter has failed to impress the Street.

Some brokerages have already revised the target price for L&T’s stock, currently trading at Rs.1,558, downward. Others are likely to watch how things pan out both on order inflows and profitability at least for a couple of quarters. Given these uncertainties, FY17 is a year of reckoning for the diversified conglomerate.

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