Larsen & Toubro's Q3FY18 results (Neutral) - Strong order inflows; execution catching up

Q3FY18 result highlights

• L&T’s Q3FY18 results were ahead of estimates led largely by lower than estimated interest and depreciation charges. PAT grew 53.2%yoy to Rs14.9bn, above estimate of Rs13.7bn.
• Revenue grew 9.4%yoy to Rs287bn, below estimate of Rs297bn, due to lower than estimated infrastructure and power segment revenue. EBITDA grew 24%yoy to Rs31.4bn (est: Rs32.5bn) led by 130bp yoy expansion in EBITDA margin to 10.9% (est: 11%). The yoy margin expansion was on the back of inventory write-off in shipbuilding and provision of Rs1bn for disputed receivables in Nabha project in Q3FY17. Overall, margins were supressed by higher proportion of revenue from projects yet to cross the margin recognition threshold.
• Working capital levels increased marginally to 21.5% as on Dec-17 as against ~21% as on Sep-17.
• Domestic revenue growth recovered to 11.6%yoy (7.5%yoy in H1FY18) led by improved execution in the infrastructure segment while international revenue growth remained muted at 5.4%yoy due to lower order backlog (down 10%yoy).
• Order inflow growth was robust at 38%yoy to Rs481bn (est: Rs430bn) with 82% of the orders received from the domestic market. Order inflows were driven by the infrastructure and hydrocarbon segments. Order backlog grew 4.7%yoy to Rs2.7trn after cancellation of Rs40-50bn slow moving orders.
• L&T has maintained its FY18 guidance of i) flat to marginal order inflow growth, ii) 12% revenue growth and iii) 25bp EBITDA margin expansion (ex-services and development business). Revenue guidance implies ~20%yoy revenue growth in Q4FY18. We estimate FY18 consolidated revenue to grow 10.8% to Rs1.2trn. 
• L&T has approved subscription to the equity shares of L&T Finance Holdings Ltd on a preferential basis for a total investment of Rs20bn.

Key positives: Strong order inflow and improved domestic execution.

Key negatives: Weak international order backlog/revenue

Impact on financials: Upgrade of 10.1%/7% in FY18E/FY19E EPS mainly due to lower interest and depreciation and higher order inflows.

Valuations & view

With L&T maintaining its revenue growth guidance for FY18 on the back of 8.2% growth in 9MFY18, asking rate for Q4FY18 has risen to ~20%, which appears steep. While we expect a reasonably buoyant 12%/14% revenue/EPS CAGR for L&T over FY17-20, valuations at 26.7x/22.4x FY19E/FY20E earnings do not offer margin of safety against risk to earnings from weak order inflow/execution. As a result we maintain our Neutral rating with revised SOTP based price target of Rs1,376.