Larsen & Toubro's rich valuations leave little room for disappointment

The stock fell over 5% after results on lower than expected show in core E&C segment, and possibility of slowdown in new orders

Larsen & Toubro (L&T) disappointed the Street with its results for the January-March quarter of the 2022-23 financial year (Q4FY23) due to weaker core engineering & construction (E&C) segment performance by the engineering giant. Although core E&C order inflows for FY23 rose 19 per cent year-on-year (YoY), with orders from railways, metals and water sectors, margins in the infrastructure segment crashed to all-time low. 

Revenue at Rs 58,300 crore was up 10 per cent YoY but somewhat below expectations. The projects & manufacturing (P&M) segment (ex-services) revenue stood at Rs 43,400 crore (up 8.3 per cent YoY) and services segment revenue was at Rs 15,000 crore (up 17 per cent YoY). The earnings before interest, tax, depreciation and amortisation (Ebitda) at Rs 6,830 crore (up 5 per cent YoY) was impacted by weaker margins. The adjusted profit after tax (PAT) stood at Rs 4,000 crore (up 10 per cent YoY).

The management guidance is cautious for FY24, with expectations of 12-15 per cent revenue growth and 10-12 per cent order growth, while core E&C margins are expected to improve by only 40-50 basis points (bps) to around 9 per cent. The results did indicate excellent financial management with net working capital improving to 16.1 per cent of revenue, from 22 per cent YoY and guidance is that it may be sustained at current levels or between 16-18 per cent range.

Cash generation was strong for the consolidated entity. L&T consolidated has generated Rs 35,000 crore of cash over FY2018-23, despite paying roughly 40 per cent of its PAT as dividends.

Investors fear that after 2024 elections, both execution and issuance of government orders is likely to slow down, given historical patterns after 2019. The company also faces strong competition from outfits like Tata Projects, Megha Engineering and Afcons, resulting in margin pressure. The better working capital management could imply faster execution, however. 

Ebitda margins in projects has slid from 9.3 per cent in FY22 to 8.6 per cent in FY23, while infra segment margins are down to 7 per cent with 120 bps drop, YoY. The company flagged higher raw-material costs as a factor in tighter margins and while cost input pressures continue, they may moderate. 

Management said that the order prospect pipeline (ex-services) for FY24 stands at Rs 9.7 trillion vs Rs 8.53 trillion at the start of FY23 – which is a growth of 14 per cent YoY. Around 68 per cent of these orders would be in infra with 25 per cent coming from the hydrocarbon segment.

The Hyderabad Metro has better prospects with higher ridership and lower interest costs. The loss levels for Hyderabad Metro reduced to Rs 1,320 crore in FY23 against Rs 1,750 crore loss in FY22. The average daily ridership in FY23 stood at 3.61 lakh, more than double the average ridership of 1.55 lakh in FY22. The company expects a grant from the state government in FY24 and hopes to scale down the Hyderabad Metro debt from Rs 13,000 crore to Rs 7,000 crore. 

The past decade has seen declining margins. Various reasons for this include timing mismatch between bid and placement of raw material orders, changes in input prices, changes in project scope, difficulties and time lost in realising claims -- and most importantly -- the L1 (lowest cost) nature of bidding. 

Most analysts are positive on the stock, while a few are negative given that it is highly valued for the segment. The average target price, according to a Bloomberg poll of analysts after results, is Rs 2,552. The stock dropped 5.3 per cent on Thursday to close at Rs 2,241.65 (FY23 price-earnings multiple of about 33x) on the BSE.