But we remain wary of risks associated with deteriorating working capital of Larsen & Toubro, higher than expected margin drag on overseas orders and a potential increase in slow moving order book. Also, valuations at 18x one year forward earnings are not cheap. A decisive improvement in the investment cycle not our base case at this point would be a necessary trigger for further re-rating, in our view.
In our base case, we expect Larsen & Toubro liquidity environment to improve next fiscal, easing working capital pressures. However, if working capital intensity remains at FY14E level (18% of sales) over the medium term, there is 6% downside to our base case target price. Large unforeseen cost provisions in overseas orders booked by Larsen & Toubro (particularly in hydrocarbon segment where complexities are higher) is a key risk to our margin assumptions.