Larsen & Toubro's Q2FY20 results (Outperformer) - Order inflow remains strong for consecutive quarter

Q2FY20 result highlights

• L&T reported another quarter of strong order inflow of Rs483bn, a 20% growth yoy. Note that Q1FY20 order inflow was Rs387bn (+11% yoy). As a result, H1FY20 order inflow was Rs867bn, a growth of 16% yoy. Given the challenging macro-economic environment, Strong order inflow is quite a positive surprise.
• Order backlog grew by 8%yoy to Rs3.0trn, 2.9x book to bill ratio revenues (ex-services and development business revenues). Note that the Electrical and Automation business sale has received CCI approval in Q1FY20 and awaiting other regulatory approvals
• Consolidated revenue grew by 15%yoy to Rs353bn (est: Rs349bn) led by growth in Infrastructure (+8.9%yoy), IT services ((+64% yoy - led by consol of Mindtree) & Financial services (+10%yoy) segments.
• Consolidated EBITDA margin came in at 11.5% (vs est of 11.4% and 11.5% in Q2FY19) in Q2FY20. As a result, EBITDA came in at Rs40.2bn (+14% yoy) compared to our est of Rs40bn. Infrastructure segment margins were 7.1% (+30bps), hydro carbon business margins grew by 260 bps yoy to 12.5% while Service segment EBITDA  margin declined by 90bps  to 12.4%.
• Profit grew by 28% yoy. Note that L&T has opted for simpler taxation regime of 25.2% for all its entities barring IT subsidiaries. Reported taxes have been adjusted for write off of deferred tax assets plus write back of deferred tax liabilities plus write off of MAT. Assuming  normal tax rate, profit would be Rs22bn (ahead of est,. of Rs21bn)
• Guidance of FY20: i) 10-12% order inflow growth, ii) 12-15% revenue growth and iii) EBITDA margin at 10.5% (ex-services and development business). 

Key positives:  Consecutive quarter of strong order inflow

Key negatives: Weak Infra margins on slow moving order (AP orders); deterioration in working capital by 300bps

Impact on financials: Increase our earnings estimates for FY20E/FY21E by 7%/8% to account for new tax regime of 25.2%

Valuations & view

L&T’s core E&C business performance continues to improve, both in terms of order inflows as well as execution despite a very challenging macro environment. Core E&C margins have been weak in H1FY20 but it is likely to improve going forward as large projects cross the margin recognition threshold. Working capital levels have deteriorated, but are likely to improve on back of strong growth and improving macro environment. We expect a strong 14%/18% revenue/EPS CAGR for L&T over FY19-21E. On our consolidated earnings estimates, stock trades at 21x/18x FY20E/FY21E earnings. We maintain our Outperformer recommendation on the stock with revised SOTP price target of Rs1775 (increased on account of low tax rate).