Macro headwinds finally catch up with L&T

Slower growth in order inflows and margin pressure are key factors to watch for.

While announcing its September results, which were largely in line with expectations, L&T’s management stated that there has been a sea change in in the operating environment. There has been considerable slowdown in orders and projects being differed or delayed. The impact of these headwinds is visible in the 21 per cent year-on-year drop in order inflows to Rs 16,096 crore in the September quarter in the engineering and construction (E&C) division, which generates 85 per cent of L&T’s revenue. What’s worse is that the company feels if the current conditions prevail, the order inflow growth could be a mere five per cent for FY12. This is far lower than its guidance of 15 per cent growth at the start of the financial year.

Though the year-on-year growth of 19 per cent in revenues and 15 per cent in net profit (adjusted for last year’s stake sale of Satyam) for the September quarter is decent, the Street took the hint from the gloomy outlook. The L&T stock despite reporting gains after the quarterly numbers were announced, slipped 5 per cent from the highs (it was down 3.5 per cent compared to Thursday’s closing) to close at Rs 1,336.

For now and thanks to its existing order backlog of Rs 1,42,185 crore, the company has maintained its revenue and profit growth guidance of about 20-25 per cent for FY12. However, the real catch could be the operating profit margins, which are down 20 basis points in September quarter (60 basis points in the first half of FY12) at 10.4 per cent. This is due to higher commodity prices and employee costs. Importantly, competition is bidding at lower margins where the price differentials are as much as 20-25 per cent while the order pool is shrinking due to weak economic growth. In this environment, the company believes there could be further downside in operating profit margins to the extent of 70-125 basis points. The company, however, is consciously taking profitable projects only in the E&C business, the main contributor.

Analysts do not see a need to change their growth expectations for FY12 in a significant manner. They expect L&T to report a growth of 20 per cent in revenue and 10 per cent in profits in the current financial year. The current headwinds are also reflecting in the stock, which has underperformed the Sensex since the start of September.

Going ahead, analysts are advising to keep an eye out on input prices, competition, investment cycle and interest rates that could have significant bearing on next years’ earnings. If things worsen, they don’t rule out some sort of valuation de-rating for the L&T’s stock which is trading at 17 times its FY12 estimated earnings. But it is not as bad as 10-11 times one-year forward earnings seen during the last crisis of 2009.