Despite weak growth in revenue in the December 2019 quarter numbers reported on Wednesday, the L&T stock rallied close to 3 per cent on Thursday. This is thanks to the good growth in profits and the management retaining its earlier growth targets for FY20 (order intake and revenue).

Besides, in contrast to the street expectations of a drop in order inflows, the company reported a 2 per cent year-on-year (YoY) growth in its consolidated order intake in Q3. This is thanks to the 64 per cent spike in international order intake, predominantly from Africa and West Asia. The domestic order inflows of the company, however, dropped 20 per cent YoY, given the economic slowdown in the country.

However, the management has guided for a strong pipeline in Q4 FY20. With an order inflow of ₹1,28,600 crore (up 11 per cent YoY) in the first nine months of FY20, the company has to get orders worth ₹66,000-69,500 crore in the fourth quarter to achieve its 10-12 per cent growth guidance. The management seems optimistic on the back of revival in demand in Andhra Pradesh (given the clarity around the capital region) and NCR (due to the lifting of embargo on construction).

Also, on the domestic front, traction is expected in orders for flue-gas desulfurisation (FGD) systems in thermal power plants. On the international front, orders are expected from sectors such as power T&D, water, metro rail and hydrocarbons. These factors should help mitigate the current lull in government-led bidding processes domestically.

Hits and misses

L&T’s consolidated revenues grew a tepid 6 per cent YoY in the December 2019 quarter to ₹36,240 crore. This is primarily due to the 5 per cent decline witnessed in the infrastructure segment (47 per cent of consolidated revenue). The execution delays, the management said, is due to multiple factors such as public interest litigations, change of government and pollution-related factors. Though the segment saw a lull in both revenue growth and order intake, the segment’s operating margin improved by 70 bps (basis points) YoY to 6.1 per cent in the December 2019 quarter, given the favourable job mix.

The weakness in the infrastructure segment was offset by growth in other segments. For instance, the hydrocarbon segment (6 per cent of consolidated revenue), saw 17 per cent growth in revenue, thanks to healthy execution. With improved efficiency and a favourable job mix, the segment also reported a 390 bps improvement in operating margin to 12.1 per cent.

However, the consolidated operating margin of the company was up by a lower 40 bps, primarily due to a 38 per cent YoY increase in staffing costs and 40 per cent increase in sales and administration costs. Of the staffing costs of ₹6,130 crore in 3Q FY20, ₹1,250 crore (20 per cent) was for hiring 21,000 employees in Mindtree. The increase in sales and administration costs is largely due to the rise in bad loan provisioning costs in the financial services business.

Despite muted growth in its operating margin, the company’s bottom-line grew 15 per cent YoY in the December quarter (consolidated) to ₹2,350 crore, on the back of lower taxes.

Outlook

Even if the company does not fully achieve its guidance on order intake for FY 2020, its order backlog of ₹3,06,300 crore as of December 2019 gives it good revenue visibility for the next 24-36 months.

That said, the removal of ground-level hurdles for the execution of domestic infrastructure orders remains key for converting orders into revenue. Delays could hurt both revenue and profit growth and add to the pressure on working capital requirements.

The company has been paying its vendors promptly to support them at a time of liquidity crunch. This has contributed to an increase in the working capital ratio (as a percentage of sales) to 23.5 per cent in Q3 FY20, from 19.6 per cent in the year-ago period.

With a 3 per cent quarter-on-quarter increase in long-term borrowings to ₹1,37,000 crore as of December 2019, the company’s debt is at about 0.8 times its equity. This favourable ratio could further improve in the coming quarters, thanks to the upcoming infusion of ₹14,000 crore from the sale of the electrical and automation business to Schneider. The management expects the deal to conclude by the end of March or in the June 2020 quarter.

At ₹1,333, the stock is trading at about 20 times its trailing 12-month earnings, lower than its 3 year average price-to-earnings of about 25 times.

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