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Healthy execution and margin improvement

Larsen & Toubro’s (L&T) Q2FY22 performance showcased it is inching towards normalcy in terms of executions and margins. Despite international supply-chain challenges, company registered 12% YoY growth to Rs347.7bn while EBITDA margin expanded 70bps to 11.5%. Current orderbook stands at Rs3.31trn as order inflow bounced back to grow 50% YoY to Rs421bn led by hydrocarbons segment. Divestment of Uttaranchal Hydro Plant was concluded with continued focus to monetise other assets. Management has guided for a stronger H2FY22 with better margins and improved working capital supported by revival in order inflow. Given the focus on margins and asset sales, we maintain BUY on the stock with revised SoTP-based target price of Rs2,083 (earlier: Rs1,857).

* Strong orderbook supported by revival in order inflow: As economy gathers pace, order intake is also improving. L&T reiterated improving order visibility with revival in government-led capex as order pipeline grows to Rs6.83trn with infra pipeline at Rs5.29trn, followed by Rs1.2trn from hydrocarbons. We expect this trend to continue and gradually gather pace during H2FY22.

* Pick up in execution with expanding margins: Level of sustainable activity is picking up despite persistent international supply-chain challenges. Workforce at site has improved to 251,000 in October from 240,000 in FY21. Commodity prices’ normalisation and better working capital management provide support for stabilising trajectory of margins.  Cash burn at Hyderabad Metro to continue: Despite revival in ridership, Hyderabad Metro continues to impact overall cashflow as L&T and the company booked loss of Rs4.47bn in Q2FY22. Further support of Rs10bn might be needed over the planned Rs20bn. Efforts to gain support from the government or refinance debt with better terms continue.

* Working capital stable; support to suppliers continue: Collections have improved and the current ‘net working capital to sales’ ratio is at 22%. Management continues to provide support to suppliers given the pandemic scenario. Net working capital is expected to be at similar levels as in FY21.

* Maintain BUY on strong balance sheet and focus on asset sales: Government’s focus on National Monetization Pipeline provides impetus to focus on asset sales, especially Nabha Power and Hyderabad Metro. Pick up in order activity and revival of hydrocarbon segment will provide further fillip to overall growth. Given the strong balance sheet, control on working capital and expected recovery of growth in H2FY22E, we maintain BUY on the stock with revised SoTP-based target price of Rs2,083 (earlier: Rs1,857).

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