EUR 120.00 For Business Accounts Only

MOSL: LARSEN & TOUBRO (Buy)-Near-term execution impact imminent; Working capital stabilization to determine extent of growth revival in FY22

(LT IN, Mkt Cap USD15.6b, CMP INR800, TP INR1320, 65% Upside, Buy)

** In this report, we highlight some of the risks that have emerged for L&T’s (Larsen & Toubro) business in the near term and its impact on earnings/cash flow.

** We expect L&T to tide over these challenging times, thanks to multiple levers in its business, scale of operations and the re-emergence as a pure EPC company.

** However, on account of worsening working capital, growth post the lockdown in India may be spaced over the next few months, impacting our near-term earnings estimates and TP.

** Execution halt in peak season to impact revenue growth: The Covid-19 lockdown in India has brought construction activities to a halt in the peak season. We note that March is a peak month for construction activities in India. Even post the lockdown, there might be some more delays in resuming construction activities in full swing as labor, machinery and materials would need to be re-mobilized. Thus, we see a clear risk to our revenue growth assumptions for 4QFY20 as well as FY21E estimates.

** Working capital likely to spike, recovery post lockdown may take time: Historically, the month of March is marked by superior execution and higher payments from government authorities, which brings down the year-ending closing working capital. However, 4QFY20 will see absence of both execution as well as payment push. Moreover, L&T would have to continue supporting its vendor base, including sub-contractors, in these tough times as it has been doing over the past many months. This is likely to increase its working capital further. Working capital as % of sales stood at 23.5% at end-3QFY20 v/s 18% at end-FY19. We fear that working capital can spike to 25% of sales in the near term, implying no FCF for FY20/FY21, despite revenue and EBITDA growth. Higher working capital is likely to weigh on the execution rate even after the lockdown is removed, thus implying that recovery may not be as swift as expected. Thus, we expect the focus to shift toward working capital management in the near term. Moreover, we believe that L&T will start showing improvement in FCF from FY22, thereby returning to the growth trajectory given its scale of operations and multiple operating levers.