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Margin guidance cut dampens an overall good show

Lower guidance on margin to outweigh the good performance

Larsen & Toubro (L&T)’s 4QFY24 result was ahead of our estimates. The company reported 15%/6%/8% YoY growth in revenue/EBITDA/PAT on a consolidated basis. Core E&C revenue/EBITDA increased 18%/22% YoY, with E&C margins at 9.5% in 4QFY24. L&T ended the year on a strong note on inflows and revenue, with 39%/26% YoY growth for core E&C driven largely by a sharp uptick in inflows from international geographies. We see positives in the 24% YoY increase in the prospect pipeline to INR12t and a sharp reduction in the net working capital cycle to 12% of net sales. However, due to the higher share of fixed-price contracts in its order book, supply chain issues, and global political uncertainties, L&T has cut its margin guidance. We also reduce our earnings estimates by 12%/9% for FY25/26 to bake in lower margins for the core E&C segment, and lower revenues for its subsidiaries. We arrive at our revised TP of INR4,000 based on an SOTP methodology. Despite lower margin guidance, we expect L&T to benefit from an improving prospect pipeline and improvements in NWC and RoEs.Reiterate BUY.

Result ahead of our estimates

L&T’s consolidated revenue grew 15% YoY to INR671b in 4QFY24, ahead of our estimate. EBITDA rose 6% YoY to INR72b and adj. PAT grew 8% YoY to INR43b. Core E&C revenue increased 18% YoY to INR509.8b, ahead of our expectations. Margin expanded ~20bp YoY to 9.5% vs. our expectation of 9%. Thus, core EBITDA grew 22% YoY to INR48.6b. Working capital improved further to 12% of sales for core E&C, and RoE inched up to 14.9% from 12.2% in FY23. The order inflow in 4Q stood at INR560.5b, down 8% YoY, led by a 25% decline in domestic orders owing to the ongoing elections. However, the order book stands at a record INR4.8t. For FY25, management has guided order inflow growth of 10%, revenue growth of 15%, NWC to sales of 15%, and a margin of 8.25%.

Prospect pipeline up 24% YoY; moderation visible in GCC prospects

L&T’s order book grew 20% YoY to INR4.8t (3x TTM revenue). The international segment now forms 38% of the overall order book. Within international, 92% comes from the Middle-East due to an upswing in GCC capex. L&T’s prospect pipeline rose 24% YoY to INR12t, owing to a sharp increase in infrastructure (at INR7.25t, up 12% YoY) and hydrocarbon (at INR3.9t, up 58% YoY) prospect pipeline. Within the domestic infrastructure pipeline, the company is eyeing large-sized projects in water, urban transportation, bridges, B&F, and renewables. With its strategy to focus on large-sized projects, L&T expects a hit rate of 20-25% in the domestic prospect pipeline of INR7.25t, which will drive growth in domestic order inflows. While the company continues to be bullish on GCC countries, the prospects have seen some moderation.

To take a calculated call on thermal opportunities

Given the rising demand for power and the need to have a base-load power source, there has been a renewed interest in thermal power in India. Notably, the government envisages an addition of ~80 GW of thermal capacity. However, despite the optimism and the fact that L&T has a demonstrated track record of setting up thermal plants and other allied capabilities, it has been avoiding participation in the ultra-mega power plants (UMPP) due to the unfavorable terms of bidding.

Lower margin guidance to bake in uncertain external environment

The company has reduced its future margin guidance to 8.2-8.3% for FY25 to bake in supply chain disruptions, an uncertain political environment, and ongoing conflicts across several areas. Beyond building a buffer in initial bids for fixed-price Middle East projects or domestic renewable projects, reduced margin guidance takes into account low margins in its key infrastructure segment. Green shoots for margin revival would come from improved margins in the infrastructure segment, improved inflows in the high-margin defense orders, and claim settlements from clients.

Focus remains on reducing working capital and improving the return profile

L&T has been focusing on reducing its working capital through improved collections and better customer advances. Despite lower margins seen in FY24, the company was able to improve RoE by 270bp YoY to 14.9% as it reduced working capital by 410bp to 12% of sales. We expect working capital to remain comfortable at around 15% of sales, as the overall project mix is changing in favor of projects that have low NWC, such as international, and mega & ultra-mega projects.

Valuation and view

We revise our TP to INR4,000 based on an SOTP methodology, valuing the core business at a P/E of 30x Mar’26E EPS and a 25% holding company discount for subsidiaries. We reiterate our BUY rating on L&T. Our multiple takes into account the continuously improving prospect pipeline and improvements in NWC and RoE, despite margins being lower than guidance.

Key risks and concerns

A slowdown in order inflows, delays in the completion of mega and ultra-mega projects, a sharp rise in commodity prices, an increase in working capital, and increased competition are a few downside risks to our estimates.

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