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Buy Larsen and Toubro Ltd For Target Rs.1,584

Healthy core margins; Execution to pick up

L&T delivered healthy operational performance despite commodity price headwinds (Core EBITDA margins of 10.2%, up 80 bps yoy) led by efficient execution, favorable job mix & sale of commercial space by realty. Core business execution has almost reached to normalization level in Q3FY21 barring few project sites. We expect L&T’s execution to gain traction in next few quarters on the back of strong order backlog of ~Rs3.3trn (3.5x TTM Core business sales). Hydrocarbon segment and heavy engineering should continue to see improving margin trends. Rising share of domestic execution backed by orders picked up in the last 2 years gives margin comfort. L&T’s focus on cash flows has been evident from the past few quarters. Working capital as % of sales would likely to remain flat yoy by Q4FY21 due to better collections from customers & advance payments for large projects. Order book diversification, global competence, technology differentiation, proven track record and cost efficiencies bode well for the company. Raise our FY22 earnings estimates marginally (~2%) & retain BUY rating with SOTP based price target of Rs1,584 as we roll forward to FY23. Core business revenue ramp up, infra margin recovery, prudent capital allocation & improving return ratios over FY21‐23E are key stock triggers.

Earnings Call Highlights‐ Management Outlook

* The management has refrained from giving guidance on revenue and margins

* Order prospect  ‐  Order prospects for Q4FY21 are at Rs2.65tn with domestic orderbook constituting Rs2.2tn. It appears government has focused on key areas to boost economic recovery such as Metro, RRTS, HSR, roads, expressways, renewables, water and T&D.  

* Orderbook – Order Book stands at Rs3,311bn with international order book constituting 20% of the total. Domestic orderbook is split across: Central govt – 12%, State govt – 34%, PSU‐41%, and Private – 15%. In challenging times, a large proportion of orders from public space would mitigate credit risk. Out of this orderbook Rs90bn is Multi‐lateral funded.

* Outlook – Reflecting on 9MFY21, the management stated performance has been robust primarily due to Govt and RBI proactiveness to create ordering opportunities and abundant liquidity. Revenue and Margins were impacted due to lack of labor availability and supply chain bottleneck in Q1 and in Q2&Q3 due to lower productivity arising out of safety protocols at the site level. The management has refrained from giving guidance on revenue and margins for EPC business. Meanwhile, services business continues to pursue profitable opportunities. And once normalcy returns, the focus would be to address refinancing of Hyderabad metro. With pandemic yet lingering and aftereffects continuing business pursuit need to factor additional risk warranted to ensure responsible conduct toward news emerging opportunities and prospects. Against such a backdrop the group would continue to pursue large project wins, smart execution of orderbook, and continue to preserve liquidity and optimum use of capital.   

* Hyderabad Metro – The company has infused Cash to the tune of Rs500 crore in Hyderabad Metro during Q3FY21. Currently average monthly traffic is at 0.1mn passengers per day, however, during weekdays ridership increases to 0.125‐0.13mn passengers per day. (PnL for Hyderabad metro as of Q3FY21: Revenue ‐ Rs0.50bn (Rs0.30bn due to passenger ridership), Operational expense – Rs0.50‐0.60bn, Depreciation ‐ Rs0.75bn, Interest ‐ Rs3.65bn; Debt ‐  Rs140bn, Equity – Rs25bn). Discussion are in process with stakeholders for refinancing, however, a substantial progress would be seen before Q1FY22E

* Strategy for Q1 & Q2 claims ‐  As most of the customers are repeat customers, the company has adopted a conciliation approach which would be win‐win situation for both the parties. As most of the customers are government parties, hence, an immediate settlement might not be possible. The management expects in the next 3‐4 quarters some of the claims to materialize.

* Realty Business – Total units as per the plan are 5600. Of these, 2600 have been sold and of the balance 3000, 1900 are contracted to be sold while unsold inventory being 1100. Response to second phase in Navi Mumbai property and Bangalore property has been favorable. The mid‐ticket segment has seen an uptick and would continue to be favorable in next 2‐3 quarters. In contracting opportunity, mass housing opportunity is seen in a more pronounced form. The management does see uptick in in healthcare, data center and low cost residential housing. The overall exposure in real estate is Rs450bn with major part being moving/execution able orderbook barring Navi Mumbai International Airport.

* Debt to prune – As a pre‐emptive measure during Covid, the parent undertook the borrowing of Rs120bn, the main reason debt levels shot up. And after EIC divestments, the company has started pruning debt. In the next 2‐3 quarter, the management expects standalone debt to come down with incremental debt at parent level being ruled out. Currently, net debt to equity ratio is 0.1 at parent level which is expected to be negligible post March.

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