Larsen & Toubro Ltd (Q3 FY16): Order inflow surprises positively

Lower margins in the core E&C division is a big concern. The management indicated that the sharp fall in margins is largely due to job mix status.

Feb 01, 2016 06:02 IST India Infoline Research Team

CMP Rs1,102, Target Rs1,532, Upside 39.0%
  • LT’s Q3 FY16 operating results were below estimates due to sustained margin pressure. However, the company registered 11% yoy increase in order inflow, positively surprising the street.
  • Topline growth was marginally lower than our estimate due to slower execution in the domestic market. Domestic market revenue was lower by 3% yoy. This was offset by 39% yoy jump in international revenues
  • OPM of 10.3% was lower than our estimate of 11.2% due to a sharp decline in infrastructure margins as many large projects were in designing phase and some provisions in heavy engineering segment
  • Lower margins in the core E&C division is a big concern. The management indicated that the sharp fall in margins is largely due to job mix status
  • PAT growth was led by higher other income (higher treasury gains) and profit from sales of Astra Microwave and Chandigarh Mall
  • Consolidated order inflow of Rs. 38,500cr was quite higher than our expectations. Order book at the end of Q3 FY16 stood at Rs. 256,500cr, higher by 13.6% yoy
  • Company has reduced its order inflow guidance from 5-7% yoy to 0-5% due to slower pickup in execution in domestic market.
  • Revenue guidance was maintained at 10-15% (9M FY16 @ 9%), while lowering its margin expansion guidance to flat to marginally higher
  • Maintain our BUY rating with a revised price target of Rs.1,523
 
Result table
(Rs cr) Q3 FY16 Q2 FY16 % qoq Q3 FY15 % yoy
Net sales        25,829       23,848            8.3       23,393          10.4
RM      (14,438)     (13,603)            6.1     (13,563)            6.5
Purchases of stock in trade        (4,611)        (4,194)          10.0        (3,434)          34.3
Staff expense        (2,411)        (1,925)          25.2        (2,433)          (0.9)
Selling and dist expenses        (1,719)        (1,236)          39.0        (1,372)          25.3
Other expenses          2,650         2,890          (8.3)         2,592            2.2
Operating profit 10.3 12.1  -186 bps 11.1  -82 bps
OPM (%)            (620)           (679)          (8.8)           (694)        (10.7)
Depreciation            (745)           (920)        (19.1)           (828)        (10.0)
Interest             452             235          92.4             219       106.2
Other income          1,737         1,525          13.9         1,289          34.7
PBT            (556)           (569)          (2.4)           (494)          12.5
Tax 32.0 37.3 38.3
Effective tax rate (%)            (147)             (89)          64.3           (110)          34.1
PAT          1,035             867          19.4             686          50.8
 PAT margin (%) 4.0 3.6  37 bps 2.9  107 bps
Extra ordinary items                 -                  -   -             310      (100.0)
Reported PAT          1,035             867          19.4             996            3.9
Ann. EPS (Rs) 44.5 37.3          19.1 29.5          50.7
Source: Company, India Infoline Research
 
Strong growth in international orders saves the day for LT
LT managed to report topline growth of 8.3% yoy to Rs. 25,829cr, marginally lower than estimate. The impact of revenue de-growth in domestic business was offset by strong execution in the international business. Domestic business witnessed a de-growth of 3% yoy on account of slower customer clearances and the company going slow in projects affected by delay in payments. Topline growth was also impacted by lower revenues in the real estate division. The impact of lower contribution by infrastructure and real estate division was offset by higher than expected revenues in power and hydrocarbon segment. Standalone revenue was lower by 1.5% yoy due to slower execution in domestic infrastructure segment (8% decline yoy).  Topline growth for the third consecutive quarter was also led by a revival in the power division. On the back of higher order backlog, the power division revenue doubled on a yoy basis. Metallurgical & Material handling, Heavy engineering and hydrocarbon division which have been a drag in revenue growth managed to register higher than expected revenue. Contribution from the development projects was higher on the back of higher toll collections and commissioning of new roads. The company has maintained its revenue guidance for FY16 of 10-15% yoy after registering 9% yoy growth in 9M FY16.
 
Margins remain pressure in core sector
LT’s margins remained under pressure on account of slower execution, under utilisation in some businesses and large projects still in its designing phase. OPM for the quarter was lower by 186bps yoy to 10.2%, lower than our estimate of 11.2%. The management indicated that lower margins were due to higher share of large projects where sales is yet to achieve the margin recognition and some provisions in heavy engineering segment. Margins were also impacted due to lower contribution from high margin real estate division. The company showed an improvement in the hydrocarbons segment. However, it indicated that closure costs in some projects would impact future earnings. MMH division registered loss at operating level due to under recoveries and slow replenishment of order book. Lower offtake from PSPCL affected Nabha power’s PLF, leading to lower EBIT contribution. LT’s core segment, infrastructure, reported operating margin of 7.9% in Q3 FY16 from 9% in Q3 FY15 and 8.6% in Q2 FY16. Standalone OPM was lower by 368bps yoy due to slower execution in the domestic building & factory segment and lower absorption of other segment overheads. The impact of the above on overall margins was offset by higher than expected EBIT in the power infrastructure. However, power division OPM declined from 16.1% in Q2 FY16 to 10.5% as was indicated by the company. The company lowered its guidance for 100 bps yoy increase in margins for consolidated entity, ex-services business to flat to marginal increase. The company highlighted that the execution scenario in domestic market continues to challenging.
 
Order inflow growth of 11% yoy, a positive surprise
LT during the quarter managed to report an order inflow of Rs. 38,528cr, an increase of 11% yoy and quite higher than our estimate. Since the company had reported orders worth Rs. 6,200cr prior in Q3 FY16, we were expecting order inflow to be lower by 15-20%. Order inflow during the quarter was largely seen in the infrastructure segment. Q3 FY16 order inflow growth was led by Roads, Railways, Power T&D, and Water Businesses. The company also mentioned that ordering activity in the Middle East remained strong in the infrastructure space. Consolidated order inflow in 9M FY16 is lower by 13% yoy and the company expects to the end with year with a flat growth in order inflow. Current order backlog at the end of Q2 FY16 stands at Rs. 256,458cr, with book-to-bill ratio of 2.6x on the TTM consolidated revenue. Order prospects pipeline for the rest of the year stood at Rs. 200,000cr. Of the total order pipeline, opportunities worth Rs. 90,000cr is expected from Infrastructure, Rs. 55,000cr from Power BTG & T&D, Rs. 8,000cr from Metal & Material handling, Rs. 18,000 from Hydrocarbon and Rs. 29,000cr from various other sectors. Of the total order inflows in Q3 FY16, share of infrastructure segment increased to 72% of total order inflows. Share of domestic orders of total order inflow for Q3 FY16 stood at 68%, lower than 75% achieved in FY15. The company has not ruled out any slippage in ordering from Q4 FY16 to FY17 as revival is economy is slower than expected. We too have lowered our order inflow estimate in FY16, leading to some rationalisation of revenue growth in FY17. The company believes ordering in the defence sector would start trickling down from FY17 and revenues for the same would be booked from FY18.
 
Near term pressures, but long term positive view intact
We believe the company is rightly placed given its strong business model, superior execution capability and exposure to diverse businesses. The company’s strong order book and focus on infrastructure projects would lead to a strong growth phase going forward. Asset monetization steps taken by the company would reduce near term balance sheet stress. On a consolidated basis, we believe lower losses in new businesses like ship building, heavy engineering and higher contribution from real estate and IT business could see an improvement in contribution from subsidiaries. The disappointment in earnings in the Oil & Gas business would be minimal going forward as the company has already made huge provisions. The government’s focus in its ‘Make in India’ theme would lead to local manufacturing of defence equipments. This provides huge opportunity for players like L&T who has invested in capacities and capabilities in the defence sector. This would also help the company to register a turn-around in loss‐making subsidiaries. We have lowered our earnings estimate for FY16 and FY17 due to slower than expected revival in execution and order inflows. However, post the sharp correction in the stock the stock is attractively placed with standalone business available at 13x FY17E P/E. We value the company on a SOTP basis and arrive at a revised price target of Rs. 1,532.
 
Financial Summary
Y/e 31 Mar (Rs cr) FY15 FY16E FY17E FY18E
Revenues 92,005 101,205 113,350 128,085
yoy growth (%) 8.1 10.0 12.0 13.0
Operating profit 11,336 12,337 14,429 16,597
OPM (%) 12.3 12.2 12.7 13.0
Pre-exceptional PAT 4,417 4,906 5,981 7,194
Reported PAT 4,768 4,910 5,984 7,197
yoy growth (%) (2.8) 3.0 21.9 20.3
Adj. EPS (Rs) 47.5 52.8 64.3 77.4
P/E (x) 23.2 20.9 17.1 14.2
Price/Book (x) 2.5 2.3 2.1 1.9
EV/EBITDA (x) 16.5 15.3 13.4 12.2
Debt/Equity (x) 2.2 2.2 2.2 2.1
RoE (%) 11.2 11.5 12.9 14.0
RoCE (%) 7.4 7.5 8.3 8.9
Source: Company, India Infoline Research
 
Segmental Results
 
   Q3 FY16 Q2 FY16 % qoq Q3 FY15 % yoy
Sales (Rs cr)
Infrastructure 11,145 9,841 13.2 8,475 31.5
Power 1,406 1,166 20.7 1,124 25.2
MMH 667 802 (16.8) 552 20.9
Heavy Engineering 648 860 (24.6) 654 (0.9)
Electrical and automation 1,337 1,301 2.8 1,135 17.8
Hydrocarbon 1,961 1,832 7.1 2,207 (11.1)
IT & Technology services 2,317 1,877 23.5 2,116 9.5
Financial Services 1,864 1,606 16.1 1,783 4.5
Development Projects 1,354 988 37.1 1,204 12.5
Others 1,766 1,554 13.7 1,631 8.2
Less: Inter segment (860) (494) 74.2 (421) 104.2
Total 23,605 21,331 10.7 20,461 15.4
EBIT (Rs cr) Q2 FY16  Q2 FY15  % yoy Q1 FY16 % qoq
Infrastructure 735 828 (11.2) 746 (1.5)
Power 168 113 48.1 45 269.9
MMH 7 49 (85.7) (24) -
Heavy Engineering (141) 77 - (4) -
Electrical and automation 108 124 (12.9) 68 58.8
Hydrocarbon (2) (54) (95.7) 40 -
IT & Technology services 424 290 46.4 386 9.9
Financial Services 301 228 32.2 244 23.4
Development Projects 239 87 174.2 213 12.5
Others 249 223 11.6 261 (4.4)
Total 2,089 1,965 6.3 1,975 5.8
EBIT margins (%) bps yoy bps qoq
Infrastructure 6.6 8.4 (182) 8.8 (221)
Power 11.9 9.7 221 4.0 790
MMH 1.0 6.1 (506) (4.3) 534
Heavy Engineering (21.7) 8.9 - (0.6) -
Electrical and automation 8.1 9.6 (146) 6.0 209
Hydrocarbon (0.1) (3.0) 284 1.8 (191)
IT & Technology services 18.3 15.4 286 18.2 6
Financial Services 16.2 14.2 197 13.7 247
Development Projects 17.7 8.8 883 17.7 0
Others 14.1 14.4 (26) 16.0 (187)
Total 8.8 9.2 (36) 9.7 (80)
 Source: Company, India Infoline Research

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