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Strong operating performance, Balance Sheet strengthens

Core E&C order inflow declines 18% YoY on likely deferment to FY22

* L&T’s consolidated adjusted PAT grew 12% YoY to INR34.2b, 9% above our estimate. PAT in the Core E&C segment grew 19% YoY to INR28.7b (12% ahead of our estimate). Margin surprise drove earnings beat.

* Balance Sheet improvement was a huge positive as net D/E (including minorities and adjusted for current investments) improved to 1x from 1.5x in FY20. This was driven by: a) completion of the sale of the E&A business, b) working capital cycle improvement to 22.3% of sales from 23.7%. FY21 brought out the core strengths of the L&T’s re-aligned business model as a pure EPC player, even though P&L was impacted.

* Core E&C order inflows disappointed in 4QFY21 with an 18% YoY decline. Domestic E&C orders fell ~25% YoY on likely deferment of orders. Bid pipeline is up 13% YoY, providing comfort. While the current order book stands strong at INR3.3t (+8% YoY), with order book/revenue ratio of 3.5x being the highest in many years, the ordering momentum becomes a key monitorable going forward.

* L&T has rightly prioritized its Balance Sheet strength over growth during the second COVID wave. While COVID 2.0 has brought on similar challenges as last year, Construction activity has been ongoing unlike last year and hence, the impact should be lower than last time. We broadly maintain our consolidated earnings estimate. We maintain our Buy rating with a TP of INR1,700/share. Utilization of cash balance towards special dividend can be a positive catalyst.

Margin surprise led to earnings beat, working capital cycle improves

* Strong operational performance: Consolidated revenue grew 9% YoY to INR481b (in line). EBITDA rose 25% to INR64b (16% ahead of our estimate). The beat is largely attributable to better than expected margin in Core E&C and Financial Services. Other income jumped 56% to INR10.3b on higher cash balance and strong treasury operations. On account of the higher tax rate, adjusted PAT grew 12% to INR34.2b (9% ahead of our expectation).

* Core E&C PAT up 19% YoY, beats our expectation: Core E&C revenue grew 10% YoY to INR368b (in line). Margin surprised positively at 10.5% (up ~80bp YoY) v/s our expectation of 9.4%. Core EBITDA grew 19% YoY to INR38.9b (9% ahead of our estimate). Adjusted Core E&C PAT grew 19% YoY to INR28.7b (12% ahead of our expectation).

* FY21 performance commendable in light of the COVID-19 impact: Consolidated revenue fell 6.5% YoY to INR1.4t in FY21. EBIDTA decline was limited to 4% at INR156b. Adjusted PAT fell 22% YoY to INR69b as the Hyderabad Metro project was fully operational at the end of FY20 and interest cost hit P&L. Core E&C revenue fell 11% to INR935b, while EBITDA declined 4% to INR80.7b. EBITDA margin expanded 60bp YoY to 8.6%. Adjusted PAT declined 6% to INR56.6b.

* Balance Sheet improvement is a key highlight of FY21: Contrary to expectations of a hit due to the nature of its business, L&T managed to end FY21 with the strongest Balance Sheet after more than a decade. Working capital cycle improved to 22.3% of sales from 23.7% in FY20. It concluded the sale of its E&A business during FY21. Consolidated net D/E (including minorities and adjusted for current investments) improved to 1x from 1.5x in FY20. Cash balance and current investments stood at INR473b v/s a gross debt (excluding development project and NBFC debts) of INR255b, thus making the core business net cash. In fact, it ended up being a big beneficiary of lower interest rates by raising lowcost debt, while strong treasury operations led to a 45% jump in other income to INR34.3b. We expect the excess cash balance to be used towards repayment of its core debt as well as a special dividend.

Update on order book and inflows

* Order book strong at INR3.3t: Order book grew 8% YoY to INR3.3t, with order book/revenue ratio of 3.5x being the highest in many years. International business forms 21% of the order book. While the international order book fell 8% YoY to INR688b on weaker order inflows, the domestic book grew 13% to INR2.6t, due to the bulky High Speed Rail (HSR) order. In terms of clientele, central/state government forms 9%/31%, PSUs (42%), and private sector (18%).

* Order inflow momentum weakened in 4QFY21: While order inflow fell 12% to INR507b in 4QFY21, Core E&C order inflow declined 18% to INR395b. Domestic E&C orders fell 25% YoY – a slight cause for concern. We note that order inflows can by bulky and there may be deferment of orders in FY22E. While overall order inflows were down 6% YoY, Core E&C order inflows fell 9% in FY21. The bulky HSR order worth INR320b supported order inflows.

* Bid pipeline better than last year: The pipeline prospects stand at INR9.6t, 13% higher compared to the beginning of last year. International/domestic market forms 26%/74% of prospects. The Infrastructure/Hydrocarbon sector forms 77%/16% of overall prospects. Stable oil prices auger well for prospects in the Hydrocarbon segment as well as improves overall prospects in the Middle East

Valuation and view

* Company fundamentals are quite strong, awaits macro tailwinds: L&T has rightly prioritized its Balance Sheet strength over growth during the second COVID wave. While COVID 2.0 has brought on similar challenges as last year, Construction activity has been ongoing unlike last year and hence, the impact should be lower than last time. We broadly maintain our consolidated earnings estimate. We expect L&T to witness Core E&C revenue/EBITDA/adjusted PAT CAGR of 12%/11%/17% over FY21-23E. Our estimates largely account for commodity price inflation risk. Our consolidated revenue/EBITDA/adjusted PAT CAGR estimate stands at 14%/17%/28% over FY21-23E, helped by lower losses in the Hyderabad Metro.

* Maintain Buy with TP of INR1,700/share: Our TP stands at INR1,700 per share on account of: a) unchanged Core business target P/E multiple of 20x v/s long-term average of 22x, and b) contribution from four listed subsidiaries, after applying a 20% holding company discount. Adjusted for valuation of subsidiaries (INR605/share contribution), L&T trades at FY22E/FY23E P/E of 17x/14.8x, providing ample valuation comfort

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