Larsen & Toubro's Q1FY19 results (Neutral) - Write-offs mask improved E&C performance

Q1FY19 result highlights

• L&T’s Q1FY19 PAT grew 36.1%yoy to Rs12.2bn, below estimate of Rs12.9bn. Gains of Rs7.5bn from divestments compensated for provisions/write-offs of Rs7.35bn in the realty business.
• Performance of the E&C business (ex-development projects and ex-services), after adjusting for provisions/write-offs of Rs7.35bn in the realty business, was reasonably buoyant. Revenue for L&T and others grew 11.3%yoy to Rs204bn, adjusted EBITDA grew 25.2%yoy to Rs16.2bn and adjusted EBITDA margin was 7.9% (+90bp yoy).  
• While infrastructure revenue grew 16%yoy, EBITDA margin declined 30bp yoy to 6.8% due to adverse revenue mix. Heavy Engineering, E&A and Hydrocarbons segments registered strong performance while that of the power segment continued to remain muted.
• Reported EBITDA grew 40.3%yoy to Rs29.1bn (est: Rs28.8bn) and EBITDA margin grew 160bp yoy to 10.3%. Strong services business performance and gain of Rs3.5bn on sale of Kattupalli port compensated for provisions/write-offs in the realty business.
• Domestic revenue grew 18.1%yoy to Rs186bn and international revenue grew 17.4%yoy to Rs97bn.
• Depreciation charges grew 17%yoy to Rs6.4bn and include impairment of Rs1bn towards investments in under development hydro assets. Effective tax rate was high at 43.5% (30.1% in Q1FY18) due to DDT on dividend income in the parent even as L&T did not create DTA on the provisions/write-offs during the quarter.  ess.
• Order inflow grew 37.2%yoy to Rs361bn but was below estimate of Rs465bn. Order backlog grew 3.4%yoy to Rs2.7 trn (~3x trailing revenue).  
• L&T maintained its FY19 guidance of: i) 10-12% order inflow growth, ii) 12-15% revenue growth and iii) upto 25bp EBITDA margin expansion (ex-services and development business – but without considering impact of provisions for advances created during Q1FY19). 

Key positives: Improved domestic execution and domestic inflows.

Key negatives: Steep provisions and write-offs in the realty business

Impact on financials: No material change in earnings.

Valuations & view

L&T continues to witness pockets of improvement in the form of strong domestic order inflows and improved execution in several segments as well as de-leveraging led by improved NWC and asset monetization. While we expect a reasonably buoyant 13% revenue/EPS CAGR for L&T over FY18-20, valuations at 24.2x/20x FY19E/FY20E earnings do not offer margin of safety against risk to earnings from weak execution. As a result, we maintain our Neutral rating with revised SOTP based price target of Rs1,448 (revision led by rise in mcap of the services business).