Published on 11/10/2018 10:55:47 AM | Source: Motilal Oswal Securities Ltd

Buy Larsen and Toubro Ltd For Target Rs.1, 540.00 - Motilal Oswal

The Monitorable Troika

Order inflow, domestic execution and working capital key monitorables

*  With LT’s announced 2Q19 orders at INR340b, we estimate 2Q19 orders at INR475b, +65% YoY and 1H19 orders at INR836b, +51% YoY. FY19E orders are expected up 12% YoY (earlier 10%) at INR1.7t; elections next year should impact 2H19/1Q20 ordering, in our view.

*  Domestic engineering and construction (E&C) execution growth has picked up post GST implementation (+15% YoY in FY18) and we expect the momentum to continue in FY19. We build in domestic E&C execution growth of 14%/15% for FY19/20.

*  As LT increasingly focuses on its 'Lakshya' strategic plan, NWC should stabilize at 20% of sales after bottoming out in 4QFY17 (18%).


Focus on the Troika—orders, execution and NWC puts LT in good stead

*  Orders:

Orders announced in 2QFY19 stood at INR340b (INR129b in 2QFY18), driven by Heavy Civil, Buildings and Factories (B&F), Transmission and Distribution (T&D), Hydrocarbons and Water segments. We estimate 2Q19 orders at INR475b (+65% YoY) with FY19 orders at INR1.7t (+12% YoY, 1H19: +51% YoY). Going into general elections in May 2019—we expect ordering to slow down in 2H19/1Q20. Historically, government orders have slowed in the quarter preceding/during the election quarter (See Exhibit 9) as the election code of conduct sets in. We now build in an 11% decline in 2H19 orders driven by: (a) high base in 3Q18 where orders were up 38% YoY to INR481b, and (b) slowdown in ordering in 4Q19 as the election code of conduct sets in.

*  Domestic E&C execution:

Domestic execution grew 16% YoY in 2H18 (+15% YoY in FY18) as the impact of GST subsided and execution normalized. We expect execution momentum to remain strong in FY19 with the government giving a push for faster project completion prior to the elections. We build in E&C revenue growth of 14% for FY19 supported by an equivalent pace of domestic execution. For FY19, we expect revenue growth of 12% (12-14% guidance) driven by a revival in execution of large domestic orders that LT has bagged over the past two years. We build in domestic E&C growth of 14%/15% for FY19/20; note 1Q20 could see a slowdown due to general elections as has been the case historically (See Exhibit 15).

*  Working capital:

NWC was brought down from 25% at end-FY15 to 20% in FY18 (albeit up from 18% in 4QFY17). We expect working capital to remain at a similar level as seen in March 2018, given higher working capital requirement to support domestic execution. LT intends to bring down NWC to 18% of sales by FY21 under its ‘Lakshya’ strategic program.


*  Maintaining Buy, TP of INR1,540:

We maintain our Buy rating with SOTP-based price target of INR1,540 (E&C business at 22x FY20E EPS, to which we add INR520 for subsidiaries). LT trades attractively at 19x/15x standalone EPS for FY19/20 (ex-subsidiaries). Key risks to our rating include (a) a sharp slowdown in government spending, and (b) a sharp fall in oil prices in the Middle East.


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