Higher order flows key trigger for L&T

Improving share of domestic orders is positive for the firm

The new year has begun on a good note for Larsen & Toubro, with the company gaining a smart city project in Pune (Maharashtra) and a hydrocarbon project in West Asia. 

While the stock has fallen by seven% in three months, the key trigger remains its healthy order wins. After the second-quarter results, a positive management commentary lifted the Street’s expectation on order inflow in FY17 by five–seven%. But, it needs to be seen if the December quarter (third quarter or Q3) order inflow  — Rs 14,788 crore (according to stock exchange filings) — is adequate to meet the FY17 targets. 

While the details of more order wins during the quarter might be announced along with its Q3 results, the current data show, orders of Rs 75,000 crore are required to be clocked in the March quarter to meet its 15% FY17 order inflow growth target. A tall task for L&T, given the sluggishness that persists in the core infrastructure sector. 

Meeting the projected order inflow target assumes immense importance for L&T, given that in the past financial year, it missed targets by a huge margin despite reducing the order inflow expectations twice.

That said, the distribution of order receipts so far across segments such as smart cities, railways, and power transmission and distribution suggests L&T’s ability to broadbase its revenues and the strategy is important as the core infrastructure segment still not out of the woods. What’s also positive is the improving share of domestic orders. In Q3, a major chunk of those announced were from domestic contractors. While this trend was also seen in Q2, sustaining the momentum in Q3 would be a sentiment boost.

Improvement in working capital utilisation is another positive. In Q2, the net working capital-to-sales ratio improved from 23.5% in FY16 to 22%. If L&T keeps up its 12–15% revenue growth target for FY17, the working capital snag might also shrink in the coming quarters. The only blip for now is the poor return ratios mainly return on equity. 

Given its investment in diverse non-core assets, investors may have to wait longer for this metric to improve meaningfully. For now, this pain point is adequately priced into L&T’s stock and work is underway to reduce its non-core exposures. Therefore, as analysts at Deutsche Bank put it, the risk-reward ratio for the stock seems more balanced. The recent correction offers a good entry point for long-term investors.