The Larsen & Toubro (L&T) stock seems to be clouded with negative sentiment. Its performance in the first quarter (Q1) of FY16 did not match analysts’ expectations and it could not keep pace with order inflow targets. Added to this is the slippage in credit rating for two of its road project and the likely delay in execution of projects in West Asia (key international market). All this has dragged L&T stock down by 15 per cent in the past three months and it is now among the list of under-performers within the basket of BSE Sensex stocks.
Any signs of improvement in order execution will be positive for the company, given that pressure in execution witnessed by segments such as metallurgical and material handling and heavy engineering dragged down L&T's profits by 38 per cent year-on-year (y-o-y) in the first quarter of FY16. This was despite a seven per cent y-o-y revenue growth that quarter. Taking cues from mixed performance of L&T, Ambit Capital is of the opinion that even if there is a cyclical capex recovery, L&T is unlikely to witness material acceleration in revenue growth as a bulk of its capital is employed in businesses that will not be helped by capex recovery.
Sharing this concern, Deutsche Bank, points out that guarantees provided by L&T to its subsidiaries in FY15 accounted for 48 per cent of its net worth on a standalone basis. If this trend continues, L&T’s ancillary businesses could become a significant concern.
To address these issues, L&T recently unveiled its plans to divest from some of its non-core assets, particularly road and infrastructure projects. According to R Shankar Raman, L&T’s chief financial officer, exit from non-core businesses and profitable growth of core businesses will lead up to five per cent improvement in return on equity (RoE), which is currently at 11.65 per cent.
Nevertheless, most analysts appear to favour L&T. Says Prabhudas Lilladher, “L&T continues to be the best play in the Indian capital goods, given its strong execution capabilities and relatively healthy balance sheet.”
Given the opportunities in defence and railways segments, Citibank, too, stated L&T is the best play on India’s infra development and economic growth.
Any positive guidance from L&T's management on order inflows for the second half of FY16 and divestment plans could be positive for the stock.