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Resilient performance

L&T’s Q2FY22 operating performance was in line with estimate and was accompanied by beat in order intake and stable net working capital levels. Recurring PAT grew 56% YoY to Rs17.2bn (est: Rs17.9bn). Revenue grew 12% YoY to Rs348bn and EBITDA grew 20% YoY to Rs40bn, with EBITDA margin rising 70bp YoY to 11.5%. E&C revenue grew 11.6% YoY to Rs228bn (est: Rs239bn) and E&C EBITDA grew 27% YoY to Rs20.9bn, with EBITDA margin expanding 110bp YoY to 9.2% (est: 9%). Order inflow at Rs421bn beat estimate of Rs302bn due to higher Hydrocarbon inflows. Operating cash flow was robust at Rs40.4bn in Q2FY22 and NWC remained stable at 22%. L&T expects a strong pick-up in activity levels in H2FY22 and maintained its FY22 guidance. E&C valuations at 12.4x/10.5x FY23/FY24E are attractive. BUY with an SOTP-based PT of Rs2,200.

Execution strong; margins remained resilient led by improved overhead recovery

E&C business posted a resilient performance during the quarter. Revenue growth was driven by Infrastructure (up 7% YoY), Hydrocarbons (up 20% YoY), and Power (up 62% YoY). E&C EBITDA margin improvement was led by Infrastructure (up 190bp YoY to 8.3%) and Heavy Engineering (up 1,060bp YoY to 15.7% on low base). Margins were supported by favorable job mix and improved overhead recovery despite commodity headwinds.

Strong order inflows led by Hydrocarbons; order prospects buoyant at Rs6.3tn

Consolidated order inflows grew 50% YoY to Rs421bn (est: Rs302bn), led by Hydrocarbons (Rs145bn). E&C order inflow grew 73% YoY to Rs301bn, significantly above our estimate of Rs185bn. Order prospects for H2 buoyant at Rs6.83tn (Rs9tn in Jun-21 and Rs6.1tn in Sep-20), driven by Infrastructure (Rs5.3tn) and Hydrocarbons (Rs1.2tn) verticals. It also includes some large-ticket orders. Mix of domestic order backlog of Rs2.5tn: Center (10%), States (33%), PSUs (42%), and Private (15%).

Guidance maintained; working towards divestment of development assets

L&T has maintained its revenue and order inflow guidance of low to mid-teen growth for FY22. L&T is confident of keeping E&C margins flat YoY at 10.3% in FY22, as 60-65% of the order backlog has PVC. Also, release of contingencies, productivity benefits and several projects crossing margin recognition threshold during the year would further aid margins. L&T is working towards divestment of development assets by selling Nabha Power Plant and is also looking to sell balance 51% stake in IDPL. It is evaluating option of third-party equity infusion in Hyderabad Metro and is targeting closure of debt restructuring process by Mar-22, which should limit support from L&T beyond FY22.

E&C business valuations remain compelling; maintain

BUY We expect 23% CAGR in consolidated EPS over FY22-24 with E&C business EPS growing at 17% CAGR over this period (E&C EPS: Rs57.6/Rs67.5 in FY23E/FY24E). L&T’s stock has risen 19% (by Rs283) since Jun-21, which has been completely driven by steep rise in stock prices of its listed IT subsidiaries. E&C business valuations at 12.4x/10.5x FY23/FY24E remain compelling, especially in light of a broader re-rating of cyclical stocks. We believe L&T has a strong potential to rerate from current levels and we maintain our BUY rating on the stock, with a revised SOTP-based PT of Rs2,200.

Valuations

We value L&T on SOTP basis at Rs2,200, valuing the E&C business at 18x average EPS of FY23E and FY24E. Other businesses have been valued at their respective market capitalization (at 20% holding company discount). Our price target has reduced by Rs15/share due to reduction in market capitalization of listed subsidiaries.

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