Margin pressure clouds near-term outlook for L&T Technology's stock

The Street wasn’t upbeat with the second quarter results of L&T Technology Services (LTTS) and its shares dropped 3 per cent on Thursday. It reported an almost flat 3 per cent rise in consolidated net profit year-on-year (Y-o-Y).

Analysts’ opinions are divided.

LTTS reported revenue of $307 million, up 3.4 per cent quarter-on-quarter (Q-o-Q) in constant currency (CC) terms. The Sustainability vertical saw 6.5 per cent Q-o-Q growth, supported by large deals, bagged earlier. The Mobility vertical hit 5 per cent growth.

Management maintains FY25 guidance of 8-10 per cent revenue growth in CC, which implies a steep growth rate of 4.5-7 per cent growth per quarter in H2FY25. The earnings before interest and tax (EBIT) margin was 15.1 per cent, a miss with decline of 50 basis points, but the management reiterated guidance of 16 per cent margin for FY25 despite wage hikes in Q3FY25. Large deal wins were lower but the company expects to close a number of $25-100 million deals in H2FY25. In the medium-term, LTTS is targeting $2bn revenue outlook with EBIT margin of 17-18 per cent.

On a Y-o-Y basis, revenue was up 6.3 per cent which is in line. Management is confident of higher revenue growth, pyramid optimisation, and improving offshoring. Deal momentum slowed sequentially to $80 mn-plus vs. $120 mn plus in Q1FY25, and an average of $130 mn plus for the last four quarters. Large deals include two $20 mn and four $10 mn deals. The company also secured two significant empanelment agreements for the Sustainability vertical. There may be a slight impact on deal closures in Q3 due to US elections.

EBIT was up 1.1 per cent Q-o-Q but down 4.9 per cent Y-o-Y at Rs 380 crore. PAT stood at Rs 310 crore, up 1.9 per cent Q-o-Q and 1.3 per cent Y-o-Y. For H1FY25, revenue grew 7.4 per cent compared to H1FY24 while EBIT dropped 3.9 per cent and PAT grew 1.1 per cent. Year-to-date (YTD) cash conversion was at 52 per cent free-cash-flow (FCF) to profit after tax (PAT).

Headcount stood at 23,698, sequentially up 0.5 per cent. LTTS expects to hire 2,000 freshers in FY25 compared to 1,500 hired in FY24. The company announced dividends of Rs 17 per share for Q2FY25. The patent portfolio stood at 1,394, out of which 877 are co-authored with customers and the rest filed by LTTS. The company is making progress in Gen AI with a total of 165 patents filed so far, compared to 61 last quarter.

Among geographies, North America was up 3.1 per cent Q-o-Q, Europe was up 5.8 per cent, India was up 3.4 per cent and rest of world (RoW) was up 6.3 per cent. The Sustainability vertical contributes 30.8 per cent of revenue, growing at 6.5 per cent Q-o-Q, Mobility contributes 35.5 per cent of revenue, and is up 4.8 per cent Q-o-Q, and Hi-tech contributes 33.7 per cent of revenue and grew 0.8 per cent Q-o-Q. Management expects growth to improve in Hi-tech due to improved demand from hyperscalers, but Mobility may be soft in Q3.

Guidance demands very good execution in H2 since the ask to achieve lower end of guidance is compounded quarterly growth rate (CQGR) of 4.5 per cent. Investments in Sales, G&A (General & administrative), and Labs pulled down margins in H1.

SG&A should normalise at the 10 per cent level and LTTS remains well placed to benefit from spending in digital engineering with significant investments behind. 

Margin expansions are expected in Q3FY25, despite wage hikes scheduled for November, which will have a temporary 80bp impact. The company expects operational efficiency levers such as pyramid optimisation, SGA optimisation, and tool utilisation to ramp up EBIT margins to 16 per cent.

Analyst recommendations range from Buy to Hold to Reduce and Sell but there’s a consensus on short-term margin downgrades.