As odd as it may sound, Larsen and Toubro Ltd (L&T) is doing a better job of portraying the current economic woes of the country than mainline indices, Sensex and Nifty. Although economic indicators continue to worsen, equity indices have been hitting new highs.
The L&T stock, considered a bellwether for the economy by some, is gradually correcting. Its forward price-earnings valuation has dropped to 16 times, according to Bloomberg data, down about 25% from valuations of over 21 times in early July. Valuations of the Nifty, meanwhile, have risen about 5% to nearly 19 times in the same period.
Weakening valuations indicate low confidence in future prospects of a company, which is bad news for the economy.
For L&T, three quarters of its revenue accrue from the domestic infrastructure and heavy engineering sectors. Recent data on core industries’ output, rail freight, electricity consumption, and auto and other manufacturing sectors’ production all indicate that the slowdown is intensifying.
The upshot: weaker capital expenditure, which in turn implies lower order flows for infrastructure companies. “Impacted by the tight liquidity scenario, infrastructure activity is under stress. Demand outlook from the private sector is also muted," says a report by ICICI Securities Ltd.
These factors have dampened the outlook on L&T’s order book growth. The company has maintained its order flow guidance for FY20 at 10-12% over FY19. But analysts have begun questioning it. “We build in 6% inflows growth, implying a miss. Hence, we revised our earnings down by -3.3/-6.1% for slower booking," said analysts at Credit Suisse Securities (India) Pvt. Ltd in a note to clients.
The analysts added that orders from the governmentare slowing down for the company, and that it expects the derating in the stock to continue.
In Q2, order flows in L&T’s domestic business declined 2%, but its international division saved the day with a 35% growth in order inflows. The 33% drop in infrastructure orders underscores macroeconomic sluggishness.
That’s not all. An increase in L&T’s working capital to 23% of sales in Q2 FY20 from 20% in Q1 FY20 was due to support extended to vendors. This mirrors the liquidity crunch in the economy in spite of efforts by the government and the central bank to mend the situation.
Despite the odds, L&T did well to report a 13.4% year-on-year growth in operating profit, on the back of a 15% revenue expansion, thanks to decent execution of its existing order book.
Yet, a confluence of negative macroeconomic factors continue to weigh on the stock. Apart from the pressures on its own order book, the company’s shares are also impacted by the general news of the slowdown. The mainline indices, meanwhile, are driving a handful of stocks that investors believe are somehow immune to the slowdown. In this backdrop, the L&T stock looks well-placed to track investor sentiment for the India story.