 "Provisioning steals the show for L&T")
Market gave a thumb down to engineering major Larsen and Toubro’s June quarter numbers. At the opening bell the stock fell the most in five years after the company posted a net profit of Rs 967 crore for April-June quarter. Growth in profit was on account of a sale of Dhamra Port which netted Rs 1,350 crore, but for which the company could have posted a loss.
Consolidated quarterly sales stood at Rs 18,975 crore, up 10% YoY. L&T’s chief financial officer R Shankar Raman told reporters that "Conditions in the domestic market are still sluggish, we are waiting for the domestic industry to pick up, growth to pick up".
As for the company’s order book, it increased by a modest 11%, helped by major infrastructure, hydrocarbon and heavy engineering orders from the export market.
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Inderjeet Singh Bhatia of Macquarie Research said in an interview with CNBC that it is too early in the cycle to go negative on quality stock like L&T. Historically for L&T Q1 is actually seasonally the smallest and the weakest quarter for them. The second half would be critical for them to reach their revenue targets. Raman said that the company is set to meet its guidance of 15% revenue growth and a 20% rise in order inflow in 2015.
Bhatia pointed out that in the current fiscal Q1 was predominantly an election quarter so the other inflows will also get impacted by that. Moreover, L&T seem to have taken a lot more provisions in this quarter so that these issues do not recur going forward.
It is these provision that can be said to be the hallmark of June quarter numbers as the company has taken benefit of exceptional items on the revenue side and made substantial provision on the expenditure side. According to Morgan Stanley, in May 2014, Adani Ports and SEZ announced the acquisition of Dhamra Ports. L&T IDPL booked a gain of Rs 787 crore on the sale and reversed the accumulated losses of Dhamra to the tune of Rs 563 crore on its books. With the philosophy that monetization (vs. holding assets to maturity) is likely to be part of IDPL’s business model; the company recorded the combined Rs 1,350 crore as revenues (against which there were no costs).
The second provisioning is on account of its hydrocarbon division. In the final quarter of FY13 L&T’s board approved the transfer of the hydrocarbon division to a wholly owned subsidiary, LTHE, for a total consideration of Rs 1,760 crore to be paid in cash by LTHE.
According to Morgan Stanley in this quarter, L&T management announced a provision of Rs 900 crore in the Hydrocarbon subsidiary to account for reversals of profits and foreseeable losses on six contracts in the MENA (Middle East North Africa) region. The losses reflected various reasons: time overruns, client delays, specification changes, increase in labour changes and unforeseen stringency in QA (Quality Assurance) / QC (Quality Control) norms.
Morgan Stanley says that this once again brings to the fore the increased risk profile from the increasing share of the MENA business. However, Morgan Stanley feels that the provision is unlikely to be repeated in the near future in Hydrocarbon. But Morgan Stanley feels that similar challenges could hit earnings from the strong inflows in the infra vertical over the last 18 months. The company’s management in the analyst call had said that their bids (on all verticals) from F2H14 onwards had been adjusted for the increase in labour costs. This means that the contracts bid before (Rs 30,000 crore of inflows in FY13 and first half of FY14) are exposed on this account. In other words there can be some more provisioning surprises, this time from the infrastructure segment.
Morgan Stanley feels that weakness in revenue and overseas risks hitting the company’s numbers the stock is fully valued at the current price. However, since the TINA (There is no alternative) factor and the exceptional management quality prevents Morgan Stanley for downgrading the company.