Current slowdown could be temporary, multiple long-term triggers in L&T

Q4 is expected to be soft and any corrections could offer a good entry in the stock

India’s premier engineering outfit, Larsen & Toubro (L&T) is a proxy play on both the infrastructure and the capital goods industry. It singlehandedly generates around 50 per cent of total revenues in some of these sectors. It also owns stakes in listed group companies, which are players in digital technology and finance. It has a finger in almost every engineering pie as well as significant overseas exposure to projects.

A preview of the likely Q4 performance suggests that the results will be on the disappointing side. Order inflow was low, suggesting the full-year guidance for the order book is unlikely to be met. Construction costs would have shot up due to higher steel and cement prices and higher freight charges due to rising fuel prices. The profitability is therefore, likely to have moderated at EBITDA levels and revenues are likely to be flat. However, profit after tax (PAT) may improve significantly since there are signs that the working capital position has improved, thus cutting the cost of financing. Speed of execution also appears to be back at pre-Covid levels.

This slowdown may be a temporary phenomenon which could even offer a chance for investors to enter at lower valuations if the street is disappointed. Most analysts calculate a likely upside of 20-30 per cent in terms of share price valuations and while costs may remain elevated, the order inflow is likely to pick up in the new fiscal. Gross margins may remain under pressure although there are pass-through clauses in around two-thirds of projects under implementation. But a higher topline would translate into higher EBITDA and bottomlines.

The company is looking at higher overseas projects since it has an excellent reputation in Africa and the Middle East – both regions where higher energy prices could translate into a willingness to launch more projects, especially in the energy sector. The merger of a wholly owned subsidiary which is a player in the hydrocarbons sector, will improve visibility of such orders.

L&T is also looking at a long-term opportunity in India’s nascent defence sector, where the government is attempting to encourage the manufacture of more indigenous items and over the next three years or so, this could mean the creation of a new revenue stream of some significance. It is also getting into the green space with both its own capex as well as tie-ups with specialised players in the green energy space. This will ensure it is a major player in green hydrogen, tying up electrolysers for manufacturing green hydrogen, and also exploring options in solar equipment manufacturing, battery storage and data centres.

L&T has outperformed the Nifty in the past 12 months with a return of 30.5 per cent (Nifty is up 20 per cent) and it has returned 10.5 per cent in the last month, slightly less than the Nifty (11 per cent). Various analysts calculate target prices of between Rs 2,200-2,450 in the next year, which is a strong upside compared to the current price of Rs 1,830.