Stock Fundamentals

Why investors should hold Larsen & Toubro for the long term

Keerthi Sanagasetti | Updated on April 12, 2020

Supply disruptions and a complete halt in operations, owing to the Covid-19 lockdown, have hit several industries. Many had been already feeling the heat of the economic slowdown.

For infrastructure companies, awarding of domestic orders had taken a hit in the first nine months of FY20. The ongoing lockdown — which is hampering execution of projects — coupled with the Centre’s infrastructure spends likely being put on the back burner, have made matters worse for infra companies. The road to recovery for them is likely to be a long-drawn affair and a challenging one at that.

While infrastructure behemoth Larsen and Toubro (L&T) is among the best-placed to ride the recovery when it happens, investors can wait until there is more clarity on the lockdown and the progress of Covid-19 before investing.

Management commentary on the impact of the pandemic on order book and project execution, and March quarter results will be critical to watch.

In the recent market turmoil , the stock of L&T has corrected more than 50 per cent from its peaks recorded in May 2019, and at the current price of ₹812, it is trading at 11.7 times its trailing 12- month earnings, versus a three-year average of 23 times.

 

Near-term disruptions

L&T reported a tepid 6 per cent growth in consolidated revenues in the December quarter, largely due to delays in project execution. Multiple factors such as public interest litigations, change of State governments, pollution-related issues and delayed execution had led to a 5 per cent dip in revenues from the infrastructure segment.

In the first nine months, L&T saw a 3 per cent decline in its domestic order inflows. The economic slowdown over the past few quarters had nearly stalled the domestic order-awarding. However, thanks to a 64 per cent spike in its international order intake, L&T’s consolidated order inflows were up 11 per cent to ₹1,28,600 crore.

The international orders predominantly came from Africa and West Asia, in segments such as hydrocarbon, power and heavy engineering.

The Covid-19 pandemic could impact L&T’s international orders as well in the coming months, as countries re-assess their priorities and spends.

Also, the recent crash in crude prices could mean a significant drop in capex spends by oil industries in the West Asian countries, implying a drop in fresh orders in the hydrocarbon business (which constituted about 14 per cent of the overall order intake in the first nine months of FY20).

Domestic order flows look bleak given the Centre’s stretched finances and focus on reviving other critical functions of the economy.

Delays in project execution, which had already weighed on the company’s performance in the December quarter, could get aggravated in the coming quarters.

Hence, L&T is most likely to miss its order book growth guidance for FY20. With an order inflow of ₹1,28,600 crore (up 11 per cent y-o-y) 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.

 

 

 

In its exchange fillings till date, the company has reported large order wins of approximately ₹35,000 crore (the company doesn’t disclose all order wins and the exact order amount).

However, L&T’s consolidated order book stands at ₹3,06,300 crore, across segments such as infrastructure (73 per cent), hydrocarbon (15 per cent), power (6 per cent), defence engineering (2 per cent), etc.

The outstanding order book offers some amount of revenue visibility for the next two years, though ground-level execution remains critical.

Also, when the sector recovers, L&T would be well-placed to ride the revival, thanks to its diversified businesses, years of expertise and strong financials. Price escalation and force majeure clauses in the contracts could also help limit the impact on (operating) margin front.

Stretched working capital

In the December quarter, the working capital as a percentage of sales spiked to 23.5 per cent from 18 per cent in FY19.

L&T was already witnessing delays in receivables, which will now further intensify, due to the lockdown.

Apart from delayed receivables, the firm might also have to cope with pending clearances on completed work for a couple of quarters.

The RBI’s measures, including a huge cut in repo rate, the targeted LTRO and temporary moratorium on interest payment obligations, however can help ease the burden somewhat.

That apart, the company has a decent debt-equity ratio of 1.8 times, which offers some headroom to borrow more to tide over the near-term challenges in liquidity and finances.

Published on April 11, 2020

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