Our FY17E estimates factor flat order flow growth vs the likely 4% y-o-y. Management focus on reducing working capital and asset monetisation with macro tailwinds from FY18E capex announcements should re-rate the stock.
Larsen & Toubro (L&T) has announced orders worth Rs 276 billion in Q4FY17E till date. Considering L&T typically has unannounced Q4 order flow (O/F) of about 40% (implies Rs 184 billion), it is poised for quarter O/F of at least Rs 460 billion. Our FY17E estimates factor flat order flow growth vs the likely 4% y-o-y. Management focus on reducing working capital and asset monetisation with macro tailwinds from FY18E capex announcements should re-rate the stock. H1FY17 order flow was up by 12% YoY at Rs 608 billion, but Q3FY17 declined 10% y-o-y, led by the 16% y-o-y domestic order flow decline. Power and Power T&D segment (Rs 204 bn announced) was supported by a sizeable Rs 53 billion order of Gas Insulated Substations from Qatar.
Higher margin oil and gas segment contributed 18% of O/F (vs 10% in FY16).With the change in guard at the defence ministry in March 2017, we understand large defence orders have been pushed to FY18E. This could be a reason L&T has not met its FY17E O/F guidance of 10% y-o-y growth. L&T’s execution pick-up should help the stock see the first round of re-rating. We believe capex cycle is showing signs of troughing and expect capex announcements to begin in H1CY18, especially within steel and oil & gas sectors.
We estimate 6% Infra + Industrial capex CAGR during FY17E-22E with 100-200 bp potential upside when announcements begin. This should contribute to our 20% FY17E-19E order flow CAGR estimate. We remain positive on L&T and maintain ‘Buy’ with a PT of Rs 2,000, valuing the core business at 16x EV/EBITDA FY18E. Risks: extensive price competition; slowdown in the Middle East. L&T is India’s largest engineering and construction company with more than seven decades of history. The company has manufacturing facilities in India, China, Oman and Saudi Arabia. Further the company has presence in technology and financial sectors.