Markets
Orders brighten the day for L&T
Summary
One factor that weighed on operating profit was the higher staff costs for the information technology services business.Larsen & Toubro Ltd’s (L&T) profitability for the quarter ending December (Q3FY23) wasn’t exciting enough. Consolidated Ebitda stood at ₹5,073 crore, missing Street’s estimates. One factor that weighed on operating profit was the higher staff costs for the information technology services business.
The negative surprise came in from a revised guidance on core engineering and construction margin, which now factors a 30-50 basis point year-on-year (y-o-y) decline over a low base, said analysts from Kotak Institutional Equities. One basis point is 0.01%. The management expects to close FY23 margin at 8.9-9%, compared to 9.5% guided earlier. “While suggesting bottoming out of margin, the company remained non-committal to the extent of recovery on most key parameters of execution, ordering and margin," added the Kotak report on 30 January.
Against this backdrop, robust order inflows bring some comfort. The capital goods company is often viewed as a proxy to the country’s infrastructure developments as government orders account for a huge chunk of its order book. Hence, the trajectory of order inflows is crucial.
In Q3, order inflows rose by 21% y-o-y to ₹60,710 crore and order book by 14% (y-o-y) to ₹3.86 trillion. In an earnings call, the management said, this year the company saw strong awarding from the domestic markets, especially in the infrastructure vertical. Domestic orders formed more than 70% of its total order book during Q3.
Further, its commentary on ordering outlook for domestic and international markets was also upbeat. L&T has a prospective pipeline of ₹4.87 trillion for Q4FY23. This has fuelled management’s confidence to retain its FY23 12-15% guidance for orders inflows and revenue growth, and it sees the potential of exceeding it.
Investors seem to be factoring the bright picture adequately. In the last one year, L&T’s shares have rallied by 11%. The stock hit a new 52-week high of ₹2,297.65 on the NSE this month and has moderated a bit from there.
According to analysts at Ambit Capital, while the Street relishes order inflow growth, L&T struggles with a difficult choice of maintaining growth, margins and net working capital/capex at the same time. “Even as valuations suggest that the Street expects it to deliver on all parameters, a miss on any one will lead to weak cash generation," said the Ambit report.
Also, remember that exposure to non-core assets has been a sour point for investors. Recently, the company announced transfer of its 100% shareholding in L&T Infrastructure Development Projects (L&T IDPL) and its subsidiaries. But that wasn’t enough to make a material impact on its earnings. There is little to cheer on the key Hyderabad Metro Project. Average ridership in Q3 stood at 3.94 lakh/day versus 3.55 lakh/day in Q2. Improving ridership and lower interest cost have helped narrow losses. The management expects this project to break even in another two-three years. This means that stake sale in this project is unlikely in the near term. Apart from this, L&T also has exposure to Nabha Power Ltd.
“While the worst of margin pressure is behind L&T, re-rating would not only depend on its core business, but also a couple of other factors such as its IT subsidiary re-rating and a further financial improvement in the Hyderabad Metro Project," said Parikshit Kandpal, institutional research analyst at HDFC Securities. That said, a short-term upside trigger for the stock is contingent on by what extent they manage to beat FY23 order inflow and revenue growth guidance and consequently outline a higher figure for FY24, on back of robust order book, he added.
