L&T, BHEL stare at lacklustre Q3

With order flows likely to remain subdued and major triggers absent, analysts foresee a tepid December quarter

Stocks of capital goods majors Bharat Heavy Electricals Limited (BHEL) and Larsen & Toubro (L&T) have been most impacted by the ongoing slowdown in domestic and international markets. Slowing pace of capex plans by the government and private players has reduced the order flows for these companies, while denting their earnings growth. Analysts believe the results in Q3 FY16 is unlikely to be any better than the September quarter.

In case of L&T, its core engineering and construction (E&C) segment came under pressure in H1 FY16 as it witnessed 210 basis points decline year-on-year in its operating margins, despite a six per cent revenue growth. Factors such as under-recovery of overheads and cost over-run weighed on the segment’s operations. That apart, legacy issues impacted the performance of its hydrocarbon business, where revenues could remain under pressure given its dependence on the West Asia region where business has been impacted due to sharp contraction in crude prices.

  With reported order flows of around Rs 6,200 crore for L&T, analysts at Kotak Research feel that inflows in the December 2015 quarter appear weak when compared to the year-ago number of Rs 14,000 crore. However, a near 19 per cent correction in L&T’s stock price since October 2015 suggests that the Street has factored-in for a tepid Q3 FY16. Though L&T's management trimmed its FY16 revenue guidance to 10-15 per cent in September ‘15 quarter (from 15 per cent earlier) while cautioning for lower order inflows growth at five to seven per cent (versus 10 per cent), analysts believe there could be further downgrade if L&T's December quarter results misses its targets again.

As for BHEL, revenue growth and operating margins would be the key points the Street would watch out for in December quarter results. Revenues for the company dipped by three per cent y-o-y in Q2 FY16, resulting in operating profit plunging by 55 per cent, while the company ended the September 2015 quarter posting loss of Rs 205 crore. Profitability in Q2 FY 16 took a beating as the share of import content shot up significantly, with nearly 65 per cent of BHEL’s orders falling under the ‘super-critical’ category. Orders falling in this category (from state electricity boards or SEBs and NTPC), require BHEL to source certain critical components from its foreign collaborators such as Alstom and Siemens. While BHEL has indicated of possible renegotiation with clients in this segment, analysts believe that falling raw material cost and rupee depreciation could limit the room for margin expansion on these projects.

The positive factor for BHEL is its healthy order inflows, which puts the company on track to achieve its H2 FY16 inflow guidance of Rs 23,000 crore. However, Rohit Natarajan of IDBI Capital points out that continued uncertainty by the ministry of environment and forests, may delay income flowing from its recently contracted orders in Telangana, which could impact its revenues in H2 FY16. Management commentary on traction in execution of orders from private players and margins on super-critical orders are crucial going forward.

On the whole, analysts appear positive on the stock of L&T with 35 out of 51 analysts polled on Bloomberg since October 2015 recommending ‘buy’, while 29 out of 49 analysts have ‘sell’ recommendation on BHEL’s stock. Nomura in its report sums up that L&T’s order backlog is only ‘slow- moving’ or ‘slow to start’ rather than ‘non-moving’ as in the case of BHEL.