Downturns have seen L&T gain disproportionate market share; upturn beginning augurs well for margins. L&T's E&C revenue and ebitda rose at 12% and 10% CAGR, respectively, in FY10-19, despite the weak capex environment.
The government’s budgetary (BE) capex allocation is up 26% YoY vs FY21 revised expenditure (RE). Overall capex, including public sector enterprises (PSEs), is up 5% YoY vs 2% YoY in FY21. L&T de-rated about 14% in the month following the Budget in February 2020, given the lack of infra focus. We cited that the company gains share in a downturn and should still manage to grow E&C in double-digits. However, the concern remained. Current Budget commentary should ease this. Maintain ‘buy’ with a SOTP-based PT of Rs1,745, valuing the core business at 10x EV/EBITDA FY23E (consol. PB 2.7x FY23E).
Roads see highest growth within key segments. Budgetary allocation to roads is up 32% YoY vs FY21 BE and 18% vs the RE. Within this, NHAI growth is lower at 14% YoY vs BE and 7% YoY vs RE. The finance minister indicated higher spend in Kerala, Tamil Nadu, West Bengal and Assam for roads. Railways is not as positive as it is up 34% YoY vs BE but down 11% vs RE in FY21E. It is likely that with the Dedicated Freight Corridor (DFC) commissioning and ramp up, railways review their needed capex plans in the light of it over the next 12 months. Defence capex muted and PSE capex down: PSE capex is down 13% YoY vs FY21E BE and down 10% YoY vs RE. This has capped overall capex rise to just 5% YoY. Defence capex is up 19% YoY vs BE but flattish on RE, which was revised higher by 18% in FY21E. Rafale delivery might have driven the rise in RE. We believe between higher indigenisation focus and rise in items banned for imports, domestic companies like L&T will see this portfolio grow at a higher rate.
Downturns have seen L&T gain disproportionate market share; upturn beginning augurs well for margins. L&T’s E&C revenue and ebitda rose at 12% and 10% CAGR, respectively, in FY10-19, despite the weak capex environment. One investor concern post FY21E Budget was overall capex rising just 2% YoY implying limited growth for L&T. However, there is no real correlation between this growth and L&T’s domestic revenue growth. We believe market share changes, sectoral diversification and higher state spending are the key reasons. With the current Budget directionally talking of growth, and overall spend seeing some higher rise, it bodes well for L&T’s margins as they should be in a position to choose projects with better profitability.
Company’s strategic five-year plan update in May-June 2021 and order flow momentum on low 9MCY20 base should be watched for. Budget has boosted confidence in medium-term order flow visibility for L&T as it also discussed setting up long-term debt financing institution for infrastructure, zero-coupon tax efficient bonds for infra companies and Rs2-trillion state support over and above the budgeted spend. Lakshya, L&T’s five-year strategic plan, ends in FY21 and any discussion on future capital allocation and ROE targets esp. w.r.t its finance subsidiary with the 4QFY21E results could be an additional upside trigger. Maintain ‘buy’ with a SOTP-based PT of Rs1,745, valuing the core business at 10x EV/EBITDA FY23E (consol. PB 2.7x FY23E). Risks: Management not following prudent capital allocation, the government infrastructure spend not reaching pre-Covid levels and growing.