Investors need to weigh L&T Tech Services’ bold growth outlook

The company is witnessing a rise in cost takeout and value engineering deals and strong deal wins are anticipated in Q4.
The company is witnessing a rise in cost takeout and value engineering deals and strong deal wins are anticipated in Q4.

Summary

  • For LTTS, to meet the implied quarterly growth rate of 4-7% for Q4FY24 might be challenging given the macroeconomic conditions.

L&T Technology Services Ltd (LTTS) management commentary may sound like music to the ears of investors in information technology (IT) stocks. The winter for the general engineering R&D (ER&D) space is over and spring may be around the corner, LTTS said in its December quarter (Q3FY24) earnings call. In fact, LTTS is of the view that this is likely to be the case for the entire industry. Yes, potential interest rate cuts by the US Federal Reserve in 2024 is fuelling hopes of revival for IT companies. Nonetheless, amid the looming global macro uncertainty and with tier-1 IT firms still cautious about near-term demand, LTTS’ outlook appears bold.

In Q3, LTTS sequential constant currency revenue growth at 0.9% missed consensus estimate, impacted by furloughs. But the management has retained its FY24 CC revenue growth guidance of 17.5-18.5% year-on-year. In contrast, larger peer Infosys tightened its FY24 CC revenue growth guidance from 1.0-2.5% year-on-year to 1.5-2.0%. HCL Technologies narrowed its overall FY24 CC revenue growth guidance from 5-6% earlier to 5.0-5.5%.

 

LTTS’s guidance implies a steep ask rate of 4-7% sequential growth for Q4FY24. The management seems fairly confident to meet the lower end of revenue growth guidance. This would be aided by lower furloughs, seasonal strength in subsidiary company SWC in Q4 and faster ramp-up of deals. Even so, meeting the guidance would be challenging. Note that the ER&D business—LTTS’ forte—is discretionary in nature and has a high sensitivity to macroeconomic conditions.

The company is witnessing a rise in cost takeout and value engineering deals and strong deal wins are anticipated in Q4. In Q3, LTTS saw six large deal wins which had total contract value over $10 million. But as the alongside chart shows, the trend has been range-bound lately and LTTS needs to close more deals to meet its ambitious target. “Large deals seem to be trending in the right direction though, further impetus is required to change the growth trajectory and more disclosures will help to analyse the trend with more granularity," said the Kotak Institutional Equities report dated 16 January.

Geographically, growth in Europe was driven by improving traction in transportation and partially by industrial production and plant engineering. On the other hand, the US was a laggard.

Further, while the headcount dropped, LTTS’ margin improvement was unimpressive as utilization was low due to furloughs and elevated selling, general and administrative costs. In Q3, Ebit margin at 17.2%, rose 10 basis points sequentially. Ebit is earnings before interest and tax. LTTS has maintained its FY24 Ebit margin guidance of 17%. Levers such as revenue growth, cost optimization and productivity measures would aid margin outlook. It aims to get back to the 18% level by H1FY26. “In the medium term, higher offshoring (aims to improve to 60% from about 58.7% in end-Q3 FY24) would be a key element in margin improvement. We expect LTTS to deliver 17.2-18.7% Ebit margin over FY24-26F," said a Nomura Financial Advisory and Securities (India) report.

Meanwhile, reacting to its Q3 earnings, the stock rose more than 3% on Wednesday. It remains to be seen whether the management confidence translates into higher revenue growth and thus, meaningful earnings upgrades. But valuations are expensive, so investors should take the upbeat outlook with a pinch of salt.

The stock trades at nearly 39 times estimated earnings for FY25, showed Bloomberg data. This is at a premium to other IT companies.

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