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Growth drivers in place

Our recent interactions with the management of Larsen and Toubro (LT) make us believe that recent concerns related to its performance are transient, such as 1) low YoY growth in domestic inflows in 9MFY24 was due to a high base of last year, particularly in domestic hydrocarbon; 2) lower-than-expected margins were attributed to legacy projects, which are now closer to completion in the next couple of quarters; and 3) high share of international projects, particularly in Saudi Arabia, where the addressable market is continuously growing. The positive factors that will drive growth ahead, in our view, are: 1) the ramp-up of domestic inflows after elections, 2) the completion of low-margin legacy projects in next couple of quarters, 3) the constant reduction in working capital and the resultant RoCE improvement, and 4) low working capital in international projects despite being fixed-price projects. We maintain our estimates and SoTP-based TP of INR4,200, valuing the core business at 28x Mar’26E EPS. Maintain Buy

Key investment thesis

Domestic inflows to start ramping up after elections

LT’s domestic inflows declined by 11% YoY in 9MFY24, due to a high base of last year, particularly in the domestic hydrocarbon segment (which had inflows of USD2b in 9MFY23). In FY24, domestic inflows are weak in hydrocarbon and refineries due to lower capex in the oil and gas sector. Adjusting for lumpy hydrocarbon orders in FY23, domestic inflow growth could have been higher. Moreover, domestic inflows from infrastructure segment for LT have started ramping up and we expect them to further pick up after elections. The company is eyeing large and mega projects from areas like transportation infra (various state road projects), high-speed rail and metro projects, irrigation projects, transmission projects, and B&F projects. Private sector capex has already started ramping up from select sectors (Refer Exhibit 4) and will get a further leg up from thermal power, PLI-led capex, and semiconductor capex.

Focused-approach toward international opportunities

LT’s international inflows surged 377% YoY in 9MFY24, primarily driven by inflows from the hydrocarbon and infrastructure segments from MiddleEast. Infrastructure inflows came from various projects in Saudi Arabia and other regions in the Middle East, where the addressable market is growing continuously. Hydrocarbon inflows came largely from Saudi Aramco (both offshore and gas-based projects). While Aramco may go slow in awarding oilbased projects, particularly for Safania and Manifa fields, it is continuing with its capex plan for gas-based projects. LT has already been shortlisted for one package of Aramco’s gas-based projects – MGS-3, as per media reports. LT is de-risking its exposure by mobilizing teams and localizing resources in Saudi Arabia for the timely completion of projects and has built a sufficient buffer for margins unlike in the last cycle when several players under-quoted on margins. LT also made negative margins in FY15. However, since FY16, LT has posted average margins of 8.5-9% in the hydrocarbon segment even in a volatile commodity price scenario during FY17-21. The hydrocarbon business also had a negative average working capital cycle during most years between FY14 and FY22, which was much better than LT’s domestic business. (Exhibit 7)

Focusing on market share gain to stay above competition

LT is focusing on increasing its market share by targeting projects that require either high technical qualifications or large sized projects. Thus, with the anticipation of a 10-12% CAGR in government capex over the long term and a large-scale recovery yet to be seen in the private sector capex in coming years, we still expect LT to grow at a faster rate. The company has consistently increased the share of large, mega and ultra-mega projects in its overall inflows, as these projects have limited competition and better working capital terms. This will further enable the company to stay ahead of competitors.

Core business valuations are closer to previous peak

Adjusted for subsidiary valuations, LT’s core EPC business is trading at 28.5x/23.2x FY25E/FY26E EPS. We ascribe 28x to two-year forward earnings for core EPC business, which is similar to previous peak in FY18/FY19 as we believe that 1) growth of L&T’s inflows and revenue over next decade is going to be better at 13.6%/13.7% CAGR as compared to 7.8%/6.3% CAGR seen over last decade of FY13- 23 as both domestic and international addressable market is expanding simultaneously and 2) constant focus on working capital which is much lower than last decadal average of 22% of net sales.

Financial outlook

Valuation and recommendation We maintain our estimates and TP of INR4,200 on LT, based on the SOTP methodology, valuing the core business at P/E of 28x Mar’26 EPS and a 25% holding company discount for subsidiaries. We maintain BUY rating on LT.We expect a CAGR of 18%/23%/26% in revenue/EBITDA/PAT over FY23-26 for LT’s core EPC division. The growth is expected to be driven by (1) 18% growth in order inflows, led by a strong prospect pipeline; (2) a gradual recovery in core EPC EBITDA margin to 9.1%/9.7% by FY25/FY26; and (3) control over working capital and NWC at 18% of sales. We expect the infrastructure and hydrocarbon segments to remain the key growth drivers for LT.

Valuation and recommendation

We maintain our estimates and TP of INR4,200 on LT, based on the SOTP methodology, valuing the core business at P/E of 28x Mar’26 EPS and a 25% holding company discount for subsidiaries. We maintain BUY rating on LT.

Key risks and concerns

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

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