Larsen & Toubro rating- Buy: Externalities impacted results

Company did very well on order inflows; guidance for FY23 appears reasonable; target price cut to Rs 2,025; ‘Buy’ rating maintained

L&T’s Q4 results print was negatively impacted by externalities on all three key fronts, with margin being hit the most. In such a context, L&T has done very well on order inflows. While inflationary environment would limit recovery in margin, we envisage L&T to sustain healthy double-digit growth trajectory and cash flow generation. Investment in new age technologies/assets over the next 5 years would be similar to the investment in hard concession assets, which L&T aims to exit over such a period. We cut SoTP by ~8% to Rs 2,025 and retain Buy.

Externalities impact results; healthy order backlog and cash flow generation enthuse: L&T reported a 10/2/9% y-o-y growth in revenues/Ebitda/PAT for Q4FY22, meeting conservative consensus estimates and meaningfully missing our estimates. While execution was impacted by supply-chain issues and focus on cash generation, margin was impacted by RM price pressure, deferment of claim settlement and project mix. Order inflows got boosted by strong ordering from overseas, growing 54% y-o-y and could have been higher but for deferment of select orders won in Q4 for want of customer approval. Order backlog also grew a healthy 9% and cash generation was healthy.

Guidance appears reasonable given starting point: L&T met FY22 guidance on revenue growth (up 15%) while missing on margin (down ~110 bps versus flat guidance) and order inflows (up 8%  versus double-digit guidance). Inflationary environment would limit prospects of L&T covering up for margin disappointment in FY2023 and L&T guidance reflects that. L&T has guided for a low-to-mid teens revenue growth, quite achievable given strong order backlog. Also note that ~98% of L&T’s order backlog is moving well. It has also guided for a 12-15% growth in order inflows. The starting point is favourable with government tender conversion ratio to orders being a low 50% in FY22 vs 70% in FY2021. This also reflects in a five-year low quantum of domestic share of order backlog at 73%.

Concessions on their way out; new business investments planned of similar quantum: L&T shared positive developments for the three concessions where L&T has ~Rs 85-bn exposure (equity+loan). L&T hinted at sale of the remaining road assets being a near-term event, followed by sale of stake in Nabha. Hyderabad metro exit may take time but L&T expects its exposure to the asset (~Rs 55 bn) to start coming down from current year. It expects to make an investment of Rs 70-75 bn into new age green technologies over the next four-five years.

We reduce Fair Value by 8%, retain BUY at reasonable 15X FY2023E core EPS valuations: We reduce our FV by ~8% to Rs 2,025 to account for 4-10% cut in core E&C EPS and lower value of subsidiaries.