Add rating on Larsen & Toubro; Heading for a weak order inflow again

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Updated: January 11, 2016 1:17:03 AM

Weak inflow in FY2016 can have medium-term repercussions on sales growth and margin

L&T’s announced Q3FY16 order inflow so far is a repeat of the weak inflow of the past two quarters. Weak inflow in FY2016 (we estimate 20% y-o-y decline now) can have medium-term repercussions on sales growth and margin. We factor in the emerging situation in our estimates and revise our target price to Rs 1,450 (earlier R1,600). Our ADD rating remains on reasonable valuations with a medium-term outlook.

Q3FY16 announced order inflow weak so far; FY2016e order inflow could decline by 20% y-o-y

L&T has formally announced an order inflow of R62 bn so far for the third quarter. This looks weak when compared to Q3FY15’s announced order inflow of R140 bn and actual order inflow of R301 bn. L&T typically announces an order if a customer has given (i) an LOI in the quarter, and (ii) the necessary approval to announce the order (several strategic orders are not announced). Accordingly, we expect more orders to be announced in the next few days.

We note that core E&C order inflow has declined by 30% y-o-y in first half of FY16 and weak announcement inflow, so far, does not augur well for Q3FY16 and FY2016 estimates. To err on the side of conservatism, we reduce our full year FY2016 order inflow to 20% y-o-y decline, versus earlier estimate of 10% y-o-y decline; this implies 2HFY16e decline of ~11% y-o-y. The weaker-than-expected order inflow for L&T, so far, has been led by (i) continued weakness or slowdown in segments like buildings & factories, power BTG/EPC, hydrocarbon and MMH, (ii) higher competitive intensity in segments where capex has picked up like roads, power T&D, railways (incl. DFC), renewables and water, and (iii) no major orders awarded (L1 of over Rs 50 bn) in longer gestation segments like defence, shipbuilding, etc., where L&T is better placed.

Consolidated E&C: execution, margin and working capital are other key monitorables

Despite a healthy backlog, L&T’s domestic E&C (engineering and construction) execution has been weak in the past few quarters and has depressed the overall execution of the company (See graphic). Weak domestic execution has been led by (i) longer gestation of the present backlog, (ii) large orders received in 2HFY15 where, given the nature of the projects, execution was insignificant in 1HFY16 (should pick-up in 2HFY16), and (iii) slow moving orders in the backlog, etc. Our analysis suggests execution should gradually pick up in 2HFY16. This, together with near-term stable margin (no major aberrations versus estimates) and working capital should provide partial succour in a very weak inflow environment. On the other hand, weak FY2016 inflow may have medium-term repercussions on sales growth and margin; we try and factor these in our revised estimates.

Revise estimates and target price; retain ADD

We revise our estimates to Rs 44 and Rs 57 from Rs 46 and Rs 62 for FY2016e and FY2017e respectively, largely led by lower order inflow and margins. We revise our one-year forward SOTP-based target price to R1,450 (earlier Rs 1,600) led by lower multiple (20X versus 22X earlier) of core E&C (engineering and construction) business and change in core E&C earnings.


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