Given strong visibility for FY20-21e, company should stand out; risk-reward is favourable; ‘Buy’ maintained
L&T’s management has maintained FY20e guidance. Q1FY20 results came in above our expectations. Q1FY19 had write-offs on a disputed project. There were no such write-offs in Q1FY20, but there could be some in the quarters ahead. Hence, we maintain our FY20e estimates. L&T’s order flow is a lead vs lag indicator of economic growth. In our view, the share price reflects favourable risk/reward, as no capex recovery upside is factored in. Maintain Buy.
Domestic order inflow rises 16% y-o-y
Management has maintained its FY20e guidance of 10-12% y-o-y order flow growth, 12-15% y-o-y revenue growth and flattish margins ex-services. Overall order flow rose 11% y-o-y and international was down 1% y-o-y. Domestic order flow was driven by PSUs and the private sector, which surprised us as the private sector has been muted in recent quarters. State and central government orders did not contribute as much, which was as expected given the national elections in May, 2019. Infrastructure, power and heavy engineering were key drivers. The prospects pipeline remains strong at $122 bn vs a FY20e required run rate of $28 bn. Andhra Pradesh is 2-3% of orderbook, which could be affected as the new government re-analyses awarded projects.
Consolidated E&C execution up 11% y/y
L&T has reported Q1FY20 results with Electrical & Automation (E&A 4.3% of FY19 sales) as discontinued operations as the company has received CCI approval for a sale to the Schneider group. Mindtree was not consolidated as the open offer was completed only in Q1. We have yet to review our FY20e-21e estimates in light of the Mindtree acquisition and E&A sale, but do not expect meaningful changes to our estimates. Consol E&C margins rose sharply, but quarterly fluctuations should not be extrapolated. Working capital rose to 23% of sales, vs 18% in Q4FY19 and 20% in Q4FY18 as L&T is supporting its vendors in the current tight liquidity scenario. We are monitoring this closely and look forward to it easing off as the year progresses.
What we like about guidance
L&T’s typical order win strike rate is 20-25%. Its FY20e expectation is based on a 23% strike rate and no defence uptick. In the current uncertain environment, we think L&T should stand out given its strong visibility for FY20E-21e.