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Order inflow winning spree continues

Likely working capital improvement to aid execution and re-rating

* Large ticket size order wins leads to order inflow assumption upgrade:

With new order announcements worth ~INR660b (at the midpoint range of the new ticket size classification) after the 2QFY21 result, YTD order inflow in the core business now stands ~INR970b, or ~84% of our last published full-year core E&C order inflow assumption. This is largely helped by large ticket size orders, including two packages of High Speed Rail and two packages of Barmer refinery project, along with chunky orders in Water, Rail, and Road sector. As we enter peak awarding season in the coming months, we expect flattish growth in core E&C/overall order inflows v/s earlier expectation of a -20%/- 14% decline.

* FY21-end order book position to stimulate revenue growth:

Even with flattish order wins in the 4Q, L&T would end FY21 with a record high order book of INR3.5t (+16% YoY). This would translate into a multi-year high order book-torevenue ratio of 3.7x, providing strong revenue visibility over the next 2-3 years. While certain large ticket size orders may have a longer execution period, its strong order book position and low base of FY21 would help in clocking over 15% revenue CAGR over FY21-23E.

* Faster economic recovery could spur revenue growth further:

As a pure play EPC company, the only impediment to revenue growth is its working capital position. As COVID-19 vaccines get rolled out, the speed of economic recovery, and hence the restoration of government revenue both for the Centre and states, holds key for infrastructure spending. The current low interest rate scenario is the best time to revitalize infrastructure spending in India. Thus, any faster than expected improvement in the macro environment is a key catalyst for L&T’s earnings growth.

* Working capital improvement likely on the cards:

The cyclical nature of the business implies that an upswing in the economic environment is likely to result in an improvement in its working capital cycle. L&T’s working capital cycle had worsened to ~27% at present from 18% in FY19. We expect working capital to improve from here on, helped by better execution, seasonal improvement in working capital cycle by 4QFY21-end, and strengthening government financials. A large part of the deterioration in working capital is on account of payables as L&T had supported its vendors with easy payment terms during the pandemic. As the situation improves for MSMEs/SMEs, normalization of payment terms should aid the working capital cycle.

* Re-rating on cards on improving core E&C outlook and ease of funding risks in the non-core business:

L&T is likely to witness a re-rating on account of: a) improving fundamentals in the core E&C business as the ordering environment picks up, and b) funding in the non-core business is largely factored into the stock price, with likely fund infusion via a rights issue in L&T Finance Holdings (INR20b as per our estimate). Hyderabad Metro losses are likely to be elevated till traffic comes back. Thanks to the E&A sale proceeds, funding risk in the noncore businesses is no longer a concern and a thing of the past from here on, at least for the next 2-3 years.

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