03-08-2021 05:08 PM | Source: Axis Securities Ltd
Buy L&T Technology Services Ltd For Target Rs. 3,200 - Axis Securities
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Engineered for Accelerated Growth

We initiate coverage on L&T Technologies Ltd (LTTS) with a BUY rating and Target Price of Rs 3,200, implying an upside of 22% from the current levels. We believe LTTS is well placed to bounce back post the COVID-19 pandemic. The recovery will be led by 1) Significant growth opportunities in cloud transformation and other digital services2) Sustainable operating margins led by better services mix and operational efficiencies3) Healthy balance sheet, strong return ratios, and free cash flow generation, 4) Superior execution capabilities, and 5) Ramp-up in new deal wins and strong client additions. These factors are expected to help LTTSin attaining sustainable growth in the longterm.

 

Our Investment Thesis Is Based On The Following Premises

Strong and diversified services across verticals

LTTS is mainly into providing ER&D services to companies operating in diverse verticals such as Transportation, Industrial Products, Telecom & Hi-tech, Plant Engineering, and Medical Devices, among others. LTTS provides both product engineering as well as process engineering (plant design engineering, manufacturing engineering, industrial engineering, and process control systems). LTTS enjoys the lowest client concentration among peers on account of the diversity within verticals. For example, the Transportation segment derives 45% of its revenues from the Automotive segment, 35% from Trucks &Off-highway, and 25% from the Aerospace segment. While the revenue contribution from the transportation vertical seems larger as a whole, it stands relatively lower as against that of pure-play automotive ERD players on a sub-segment level.

 

Horizontal expansion strategy to provide exponential growth

LTTS has deployed a robust horizontal technology strategy wherein it engages more than 65% of the total employees in horizontals and starts penetrating horizontals in existing top accounts. This is expected to help it to improve resource utilisation, increase adaptation of solutions across verticals, and put the company in the sweet spot to deliver sustainable revenue growth moving forward. Furthermore, technology shifts in verticals will prove to positive events for LTTS as any technology change will create huge growth opportunities for ESPs.

 

Accelerating demand for digital ER&D services

The ER&D industry is shifting its focus from pure-play mechanical and structural engineering to higher use of electronics and software. With a significant portion of global ER&D spending going into the creation of smart, connected, and intelligent products, digital engineering has become a prime focus area for enterprises across industries to be able to stay relevant for the clients. Digital engineering spends are accelerating across verticals and it is expected to contribute 53% of ERD spending by 2025 as compared to 30% in 2019. There will be rapid scaling for digital adoption driven by organizations ready to shift from traditional to digital engineering. Key verticals such as Manufacturing, BFSI, Media &Technology, Retail, Healthcare Payers &Providers, and Travel &Hospitality are building new products and services to drive differentiation in their respective industries.

 

Robust long-term growth outlook – Recommended BUY

We believe LTTS has a resilient business and provides earnings visibility over the long term structure given its multiple long-term contracts with globally leading brands. We believe LTTSis well-positioned to capture the immense growth opportunity in the industry considering 1) Smooth transition of management; 2)Focus on client retention for long term sustainable growth; 3) Margin tailwinds, driven by cost efficiencies, lower input costs, rupee depreciation, and lower travel cost; and 4) Healthy cash flow generation. We assign 27x to its FY23E earnings of Rs. 120 per share to arrive at a Target Price of Rs.3,200/share, implying an upside of 22% from CMP.

 


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