Expected recovery in infra sector margin behind 2-3% rise in core E&C estimates; deleveraging pace likely to increase; ‘Buy’ retained.
Even as stressed businesses in Hyderabad Metro and shipbuilding/forgings JV would require funding for the next few years, start of cash flows/monetisation proceeds from other long-gestation businesses would provide support. The core E&C business has seen significant reduction in net debt over the troublesome FY2013-18 post large dividend payout. A stabilising backlog mix, good ordering prospects, potential bottoming out of key infrastructure segment margin and most of the stressed businesses becoming self-sustaining should accelerate (i) the pace of deleveraging for L&T and/or (ii) the rewards for shareholders. BUY.
Large cash flows generated in troublesome past five-year period: Our analysis of the annual reports shows that the consolidated-ex-services business witnesses a marked decline of net debt over the past five years despite (i) a large dividend-related payout, (ii) tepid low single-digit Ebitda CAGR and (iii) sharp increase in days of sales of working capital. Reported standalone cash flows also suggest strong ~ `120 bn of free-cash flow generated over FY2013-18 to get deployed into investments/loans to subsidiaries and dividend payout. The fact that FY2018 is the second consecutive year of declining borrowings for L&T standalone speaks of the kind of cash flows its E&C business generates.
Future looks better as most long-gestation businesses have become self-sustaining: We expect significant moderation in requirement of funding from subsidiaries over the medium term, assuming no further divestments or new asset addition. Incremental addition would be limited to the loss funding of shipbuilding and forgings JVs and pending equity commitment/loss funding of Hyderabad Metro. Over the past few years, most of the other stressed businesses have become self-sustaining: (i) The power boiler JV is now net cash, (ii) the debt of the turbine JV has peaked out, (iii) L&T IDPL’s borrowings have declined in FY2018 and (iv) L&T Hydrocarbon Engineering now has nil gross debt.
Margin likely to bottom out: For the core E&C business, the key infrastructure segment margin has not improved in FY2018 despite increasing domestic share of revenues; we note rapid increase reported in provisions against receivables. We expect recovery in infrastructure segment margin based on (i) impending closure of FY2014 overseas order wins and (ii) stabilising share in revenues of the B&F segment. We, however, do feel concerned with rapid increase in contingent liabilities. We increase our core E&C estimates by 2-3% primarily on higher infrastructure segment margin. Weakness in Hyderabad Metro and forgings business yields unchanged Rs 1,600 target price.