Larsen & Toubro Rating ‘buy’: Execution issues impact numbers

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Published: January 25, 2020 1:55:22 AM

Improvement in core Ebitda margin key positive; project deferrals expected to be resolved soon; ‘Buy’ maintained

Larsen & Toubro, Larsen & Toubro shares, Larsen & Toubro resultOrder inflows at Rs 416 bn (+2% y-o-y) in Q3 were much higher than our estimate of Rs 280 bn (9MFY20 order inflows of Rs 1,286 bn were up 11% y-o-y). Domestic ordering remains muted at Rs 237 bn (-19% y-o-y). Order inflows were largely led by international order inflows at Rs 179 bn (+56% y-o-y). Management maintained its guidance for order inflow growth at 10-12% in FY20. This implies order inflows of ~Rs 600 bn in Q4FY20, thus meeting the lower end of the guidance. Buy retained.

Management highlighted a robust pipeline of projects worth Rs 3.0 trn for Q4FY20, including Rs 0.5 trn worth of international orders. Thus, in the absence of project deferrals, the 10-12% order inflow growth guidance seems achievable.

Execution headwinds from project deferrals, but with resolution now in sight we expect contribution from such projects Q4 onwards: Q3FY20 revenue at Rs 362 bn (+6% y-o-y) was much below our estimate of Rs 389 bn and the consensus estimate of Rs 393 bn (9MFY20 revenue of Rs 1,012 bn is up 10% y-o-y). However, project execution was delayed due to project reviews/deferrals of orders from Maharashtra and Andhra Pradesh, as well as air pollution related work stoppage in Delhi region. According to management, these delays accounted for ~Rs 25-30 bn of revenue loss in Q3FY20. Management notes that ~5% of the order book was non-moving for 9MFY20. However, now with execution of the coastal road project having resumed (Rs 75 bn of orders), the level of non-moving orders has now fallen to 2.7% of the current order book of Rs 3.06 trn on our estimates. Management has maintained its guidance of 12-15% revenue growth for FY20.

Larsen & Toubro, Larsen & Toubro shares, Larsen & Toubro result

Working capital levels remain elevated but stable, as reflected in strong OCF: Net working capital (NWC) remained at 23.5% of core sales, similar to 23% in both Q1FY20 and Q2FY20. Since NWC levels are stable, there has been strong OCF generation of ~Rs 25 bn for Q3FY20. Payable levels still remained low due to liquidity stress at vendors, while receivables and inventory were broadly stable.

Core sales declined by ~3% y-o-y in Q3FY20 led by a 5% y-o-y fall in infrastructure revenue. However, core Ebitda margin improved ~20bp y-o-y to 8.9%: This is despite Q3FY19 having Rs 5.5 bn of gains in the Others segment, which was not present in Q3FY20. We had noted in an earlier report that due to commodity price declines, we expect a 55-60bp y-o-y improvement in core Ebitda margin in 1HFY21, which we view as a key catalyst for the stock.

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