Valuations may cap upsides for L&T Tech stock, no major triggers seen in Q3

While outlook remains strong, Q3 revenue growth was lower than Street estimates

The stock of L&T Technology Services (LTTS) was the biggest loser among the Nifty IT and Nifty Midcap 100 constituents, shedding 6.3 per cent in trade on Wednesday. The decline was on account of the December quarter (Q3FY22) performance, which was a mixed bag, lower-than-expected guidance, and expensive valuation.

The Q3 performance, especially on the revenue front, was below expectation. The company reported 4.3 per cent constant currency growth on a sequential basis; the Street expected this number to be 80-100 basis points higher.

The decline in a seasonally weak quarter was on account of a muted performance by the industrial products and medical devices verticals, which were up 0.7-1.5 per cent. The two together account for 31 per cent of the revenue. The largest vertical, transportation which contributes 32 per cent to the revenue, saw a robust uptick at 4.9 per cent on a sequential basis.

The company has maintained its FY22 revenue growth guidance of 19-20 per cent; indications are that it may end at the upper end of the band. Some brokerages expected the company to revise its guidance upwards. The demand environment and the deal pipeline remain healthy. This, according to Aniket Pande and Aditi Patil of Prabhudas Lilladher Research, is reflected in increasing deal pipeline every quarter, the highest-ever headcount addition, and healthy deal momentum.

The company added its biggest number of employees in the quarter -- 2,135. Over the past nine months, LTTS had added 3,000 freshers and plans to add a similar number in FY23. LTTS bagged three deals with a total contract value of $10 million in Q3. It has also announced a $45-million deal win with a US-based Tier-1 automotive company.

The outlook remains robust as enterprises are spending strongly on digital engineering programmes, with imperatives of cost efficiencies and faster speed-to-market, according to Kawaljeet Saluja and Sathish¬kumar S of Kotak Institutional Equities. LTTS is well positioned to benefit from this spending given multi-vertical expertise, strong digital engineering capabilities, and marquee client base, they added.

Even as Q3 revenue growth was sub-par, the margin was the best-ever at 18.6 per cent, up 20 basis points on a sequential basis and above Street estimates. The gain was on account of pyramid optimisation, operational efficiencies, and rupee depreciation. Motilal Oswal Research expects the company to surprise on the upside (FY23 margin guidance of 18 per cent), given pyramid benefits from higher fresher intake, better record on attrition than peers, and improvement in the margin of the telecom vertical.

In view of the expected strong growth and margin, most brokerages have revised their earnings per share estimates upwards for FY23. However, Kotak Institutional Equit¬ies has downgraded the stock to ‘reduce’ on its expensive valuation. While CLSA Research has an outperform rating, it believes that there are no major triggers from Q3FY22 and this can cap near-term upside. The stock currently trades at 44x its FY23 earnings estimates.