Margin worries to persist for L&T over inflation, supply chain concerns

While target prices indicate healthy upside, the stock has been an underperformer

Although engineering major Larsen & Toubro (L&T) missed street estimates, it did deliver growth. The guidance seems achievable and despite forward estimates and valuations being pared, most analysts have maintained buy recommendations on the stock.

Margins have been hit and there are concerns about the inflationary environment and about supply chain issues. However, order inflows have remained healthy and the company looks capable of maintaining double-digit growth and free cash flow generation. It is also looking to invest in new technology assets.

On a year-on-year (YoY) basis, the company reported a 10 per cent growth in revenues, coupled to 2 per cent growth in operating profit and 9 per cent growth in net profit for Q2, 2021-22. On the order front, overseas orders grew over 50 per cent YoY while overall order inflow was up 8 per cent. Order backlog also grew by 9 per cent but cash generation was healthy. It missed margin guidance with the operating profit margin (OPM) down 110 basis points. The latest guidance is for 13 per cent revenue growth, which seems achievable. The company has also guided for a 12-15 per cent growth in order inflows – the order book is now at Rs 3.6 trillion.

The management is also optimistic on the situation in three concessions where it has Rs 8,500 cr exposure (equity and debt).  It hopes to sell off its road asset portfolio in the near-term, and also sell its stake in Nabha power plant. While exit from the Hyderabad Metro may take time, L&T expects its exposure (Rs 5,500 cr) to reduce – rising ridership has made the Metro positive at the operating profit level. The hope is to make the balance sheet debt free by 2025-26.  

On the investment side, it targets investments of Rs 7,000 crore-plus into green technologies over the next five years. Target areas include electrolyse manufacturing (Rs 1,000 crore), battery storage (Rs 3,000 crore) and data centres (Rs 3,000 crore). The Gulf and Africa remain key regions for orders.

Margin pressures will persist – the drop of operating profit margins was caused by a combination of delayed claim settlements, commodity inflation which affected raw material costs and delayed executions. Most orders have price variation clauses and guidance indicates core OPM could be at 9.5 per cent which is about 0.5 per cent lower than in 2020-21.

Various analysts have valuations and 12-month target prices in the range of Rs 1,850- Rs 2,295 which indicates a healthy upside from the current Rs 1,536 levels. But the stock has underperformed with 2 per cent correction in the last year and 12 per cent correction in the last month.