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MOSL: LARSEN & TOUBRO (Buy)-Superior execution overshadows margin miss

LARSEN & TOUBRO: Superior execution overshadows margin miss; Domestic E&C revenue grows robustly by 18% YoY despite election period

(LT IN, Mkt Cap USD28.7b, CMP INR1410, TP INR1790, 27% Upside, Buy)

 

• PAT exceeds estimate by 10%: Including the E&A business for a like-for-like comparison, consol. revenue grew 9.8% YoY to INR311b - in line with our estimate. EBITDA grew 22% YoY to INR35.5b, with the margin at 11.4% (our estimate: 11.5%). Helped by lower depreciation and taxes (adj. tax rate at 30.2% v/s our estimate of 33%), adj. PAT increased 29% YoY to INR15.6b - 10% ahead of our estimate.
• Core E&C surprises on execution led by domestic business: Overall core E&C revenue (incl. E&A) grew 10.7% YoY (our estimate: 8.0%), despite expectations of a slowdown amid the election period of Apr-May, led by superior execution in the domestic market. Domestic E&C business revenue increased 19% YoY, driven by 27% growth in the domestic infra segment - a key surprise. However, margins in the core business stood at 7.9% (like-for-like contraction of 60bp, if adjusted for realty losses in the base quarter) v/s our estimate of 8.2%. Margins were weak across segments, particularly in the infra segment (-40bp).
• Order inflows surprise too: Order inflows increased 11% YoY in 1QFY19. This augurs well compared to management's guidance of 10-12% growth with back-ended ordering. Power segment benefited on account of the Buxar Thermal Power Project, Bihar. The said mega order more than offset the decline in order inflows in the infrastructure (-10%) and hydrocarbon (-28%) segments. Order inflow growth was led by domestic business with 16% growth, whereas international order intake remained flat. While ordering from state and central government remained subdued due to elections, the PSU and private sector contributed 90% of new ordering. Strong start on order intake poses an upside risk to management's guidance, in our view, as the center and state government orders are likely to pick up with the election uncertainty now behind.
• Working capital cycle to return to normalcy: Working capital as a percentage of sales deteriorated to 23% from 21% in 1QFY19 (FY19: 18%). This is largely attributable to the liquidity crunch for the industry and as L&T had to support its suppliers. Moreover, payments from state and central government were not fluid due to elections. We note that there is seasonality in the working capital cycle as it tends to rise in the first half of the fiscal year. LT has demonstrated superior working capital management over the past five years, with working capital declining from 25% in FY15 to 18% in FY19. We believe that once the liquidity scenario eases out, working capital will be back to normalcy.
• Valuation and view: We cut our core E&C EPS estimate by 7%/5% for FY20/21 on account of lower EBITDA margin assumption and reduced other income in the light of the MindTree acquisition. Consolidated EPS cut is limited to 2%/1.6%. We include MindTree stake in our SOTP valuation (20% discount to current market cap, in line with our methodology for other listed subsidiaries). We continue valuing LT’s core E&C business at FY21E target multiple of 22x. Accounting for the current market price of listed subsidiaries, our TP stands at INR1,790 (prior: INR1,850). Maintain Buy.