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Larsen & Toubro rating – Buy: Firm positive on prospects in fiscal

Capex level expected to be sustained if oil prices are in $80-100/bbl range; ‘Buy’ retained with unchanged target price of Rs 1,995

Defence prospects can increase significantly: L&T was earlier securing defence orders at Rs 20-30 bn annually (pre-FY22) and this increased to Rs 60 bn+ in FY22.

We hosted Larsen & Toubro’s (L&T’s) management at the Nomura Investment Forum Asia 2022 on 8 June, 2022. Key takeaways from our interaction are:

Management views the Centre’s estimate of revenue receipts of Rs 27 trn as conservative, based on current tax collection trends. Further, with the RBI’s estimate of 7.2% GDP growth and 6% inflation (or 13-14% nominal GDP growth) for FY23, tax collections could be higher than budgeted. It believes there is adequate fiscal space for providing relief to Indian consumers on inflation, and at the same time maintain the trend of infra investments. With general polls due in early 2024,it expects ordering to remain strong in the near term.

Rise in crude oil price is negative, but could revive Gulf Cooperation Council (GCC) spends: Higher crude prices often lead to less fiscal space for governments in India for capital spends, but boost capex prospects in the Middle East. Thus, a crude oil price of $80-100/bbl is supportive of capex both in India and GCC.

Public capex to gain strength in FY23: Strong tax collections could support central capex, and significant devolution of resources to states may also enable momentum in state capex. Ordering activity has been slow lately owing to the sharp surge in commodity prices. However, a rise in COVID-19 cases and a surge in oil prices are downside risks to public capex.

Firm expects pick-up in private capex: Management noted that the share of private orders in its domestic order book rose from 13% in FY21 to ~19% in FY22. However, geopolitical tensions and the resulting surge in commodity prices and supply chain disruptions have adversely affected sentiment for private capex. With strong corporate balance sheets, lower risk aversion for banks to lend, coupled with Centre’s impetus in the form of the PLI scheme, L&T expects private capex to pick up in H2FY23F.

L&T will be selective in bidding: Management had previously guided for 10-12% growth in order inflows (and revenue) based on a 18-19% win rate on a prospect pipeline of Rs 8.5 trn. It clarified that the prospective pipeline is lower for FY23 vs that at end-FY22 of Rs 9.07 trn as given a strong order book, L&T does not intend to participate in small value orders and will be selective in bidding.

Defence prospects can increase significantly: L&T was earlier securing defence orders at Rs 20-30 bn annually (pre-FY22) and this increased to Rs 60 bn+ in FY22. The thrust on indigenisation by the government can lead to further rise in prospects.

Maintain Buy; our top pick in the ESG space: We value L&T on an SOTP basis on FY24F to arrive at our TP of Rs 1,995, implying 26% upside, and maintain our Buy rating. We expect significant improvement on ESG metrics for L&T over FY22-26F, potentially driving a re-rating.

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