Despite the economic slowdown and the general elections, L&T’s core E&C domestic business has witnessed growth of 16% in 1HFY20. However, we recall that ~Rs 160 bn worth of orders pertaining to Andhra Pradesh and the Mumbai Coastal Road project are slow-moving currently.
We have revisited our order inflow assumption to factor in risks of capex cuts and the likely delay in order awarding from Maharashtra post the change of government in the state. L&T’s sensitivity to the cut in Centre’s capex is quite limited as it forms just ~20% of the order book, with limited contribution from roads, railways and defence. Our overall order inflow assumption stands at 9.6%/10.8% for FY20/FY21 with core E&C order inflow growth estimated at 5.2%/8.8%.
Minor near-term hiccups in execution may not be ruled out
Despite the economic slowdown and the general elections, L&T’s core E&C domestic business has witnessed growth of 16% in 1HFY20. However, we recall that ~Rs 160 bn worth of orders pertaining to Andhra Pradesh and the Mumbai Coastal Road project are slow-moving currently. Additionally, we suspect near-term slowdown in construction activity in Maharashtra owing to state elections and delay in formation of a new government. Due to lower order inflow assumption and near-term risks to execution, we lower our FY19-21e revenue CAGR to 12.4% from 14.1% earlier. 2HFY20 ask rate for core E&C is at 12.8%.
But, L&T is better off than peers
Thanks to L&T’s well-diversified business across verticals as well as geographies, it is in a better position to overcome macro challenges compared to mid-cap EPC companies dependent on any single segment or geography. For instance, post the formation of a new government in Andhra Pradesh, uncertainty around the choice of the capital city had a negative impact on NCC (not rated), while the impact on L&T was quite limited.
Sealing of E&A sale deal and return of cash to shareholders can re-rate stock
We expect the conclusion of the E&A sale to happen in Q4FY20. This would result in gross proceeds of Rs 140 bn. With no major capex and aversion to capital allocation in the asset business, there is a high likelihood that L&T may announce special dividend to return excess cash to shareholders, especially as the new tax rules for buyback has made it redundant for the company to choose between the two options. Any such move in Q4FY20 can be a re-rating catalyst. Additionally, any improvement in the macro environment would be beneficial for the stock.
Valuation and view
We cut our core E&C EPS estimate by 1.5%/3.4% for FY20/FY21, incorporating lower order inflow/revenue growth assumption. Consolidated EPS has been cut by 1.3%/2.6% for FY20/FY21. We have also lowered our target P/E multiple on core business to 20x from 22x on account of macro uncertainties. Accounting for the current market price of listed subsidiaries, our TP stands at Rs 1,680 (prior: Rs 1,830). Adjusted for the valuation of subsidiaries, the stock trades at FY20/FY21e P/E multiple of 19x/15.6x v/s its long-term trading average P/E multiple of 23x. Maintain Buy.