L&T- CLSA.
Rajesh Desai
L&T: Margin surprise but orders . . .; CMP Rs.1440, TP Rs.1750; Buy (CLSA)
E&C margin up 180bps; many bids but orders taking time
L&T’s 3QFY17 rec. PAT was in-line but was much better in quality. The
company’s margin was so good that even after provisions of Rs3.7bn it
delivered PAT growth of 39% YoY. Inflow (-8%) and execution (+1.4%)
were disappointing. The company cut its FY17 inflow & sales guidance to
10% vs 15% & 12-15%, though consensus was already below. The key
issue to watch is whether L&T is able to rebuild its backlog (+1.4%) in 1H
to improve visibility. We cut our EPS ~5% on the shift to IndAS (non-cash
charges). We rate the stock BUY as we believe it is a good proxy for
domestic Capex, which is taking time but is increasing, and the company
has a credible strategy to improve growth and ROE (link).
Solid margin compensates weak execution; orders key
Led by a focus on its balance sheet rather than its P&L and some impact from
demonitization, L&T’s EPC execution slowed in 3Q to +1.4%. Despite this, its
margin expanded 140bps on many ‘cost-jobs’ crossing over to the margin
recognition phase and a rebound in the margin for hydrocarbon and heavy
engineering (Figure 2) as legacy orders ended. L&T’s cleaning up of its
backlog in 2Q and 8% decline in 3Q inflow led to a slowed order book (+1.4%
YoY). On the call, management said it has lowest bids plus likely pipeline wins
of US$10bn but the government decisions are taking time.
Middle East orders and execution continue to surprise
While domestic order inflow was weak (-15% YoY) during 3Q, Middle East
(ME) helped L&T with order growth of 26%. Also ME execution was strong
despite market perceptions to the contrary. The infrastructure segment
margin expanded 110bps despite it being solely driven by ME, pointing to a
decent margin there. The key disappointment for Indian orders was the long
delay in the Vajra gun order and delay in the US$2bn LPD tender opening.
Earnings quality much better with many conservative provisions
L&T factored-in many proactive provisions, such as Rs2.7bn for asset
impairment on the likely divesture of Seawoods Mall and Rs1bn for its utility
business. L&T also did not recognise Rs800m in interest cost it claimed from
NHAI for stopping tolls for 24 days after demonitization in 3Q.
Focus on the balance sheet vs P&L shows; divestures on-track
L&T’s focus on its balance sheet rather than chasing P&L growth in this
liquidity constrained environment was reflected in the company reducing its
working capital to 21.5% in 3Q vs 24% in FY16 and a peak of 26% (Figure
15). Consequently, L&T tripled 3Q CFO to Rs26.8bn (Figure 28). The company
also recognized Rs14bn (70%) as an advance on the likely divesture of
Katupalli Port from ADSEZ, indicating the deal is close to completion.