L&T is an Indian multinational conglomerate with interests in Engineering, Construction, Manufacturing, Technology, and Financial Services.
Motilal Oswal Retail Research has maintained 'Buy' rating on Larsen & Toubro.
Key highlights and Investment rationale
Company fundamentals fairly strong, await macro tailwinds: Since its last five-year plan announced in CY16, L&T has been strengthening its business model by exiting non-core businesses, going asset-light (no exposure to road HAMs), and sharpening its focus on receivables rather than just execution. It continued to prioritize Balance Sheet strength over growth during the COVID-19 pandemic. While the second COVID wave brought on similar challenges as FY21, Construction activity was allowed to continue (unlike last fiscal). Hence, the impact was much lower than that seen in FY21. Labor availability no longer poses a challenge, with the current strength at 235k (v/s the peak requirement of 250k), which is fair given the monsoon season. The management has maintained its FY22 low to mid-teen growth guidance in order inflows and revenue. It has guided at maintaining core E&C margin at FY21 levels. L&T is poised for strong earnings growth momentum, whenever order inflows gain momentum.
Order inflows disappoint, but L&T remains the best story to play the capex upcycle: L&T's core E&C business remains best placed to benefit from any capex upcycle, supported by its leaner asset-light business model and diversified segments. Although the Buildings and Power segments were weaker in FY21, this was largely offset by strong orders in the international Power T&D and Hydrocarbons space. L&T’s capability to win large ticket size projects, such as Airports and high-speed rail (HSR), has been remarkable and compensated for its exit from the Roads sector. On account of the pandemic, order inflows have been weaker, especially if adjusted for a one-time big ticket size order (HSR project) and weak state finances. However, things should start to improve as we move past the pandemic. The bid pipeline has improved sequentially, with the overall pipeline for the remainder of the year at INR8.9t. The strong bid pipeline is encouraging, but faster conversion into final awarding holds the key. The order book is strong at INR3.2t, with the book/sales ratio at 3.2x.
Catalysts to watch out for: Over the next two years, we see multiple catalysts emerging for L&T, including: a) asset monetization for the Hyderabad Metro and Nabha Power, b) FCF generation of USD1.5-2b p.a. in the core business, c) improvement in order inflows prior to the elections, and d) improved execution, aided by a better working capital cycle, as the government focuses on capex towards economic growth and job creation. If the macro environment improves, strong FCF generation should enable L&T to hike dividend payouts, given the minimal capex requirement.
Valuation and view: L&T is our top pick in the wider Capital Goods space as a proxy to play India’s capex story. So far, weak order inflows have impacted the stock's performance, but will gain momentum once final awarding picks up. We estimate an FY21-24E EPS CAGR of 24%, driven by 15% CAGR in the core E&C business and declining loss from the Hyderabad Metro. Over last one month, L&T Infotech/ Mindtree/ L&T Technology Services rallied by ~18%/~28%/~11%. Factoring in the CMP of the listed subsidiaries (holding company discount of 20%), our TP for L&T now stands at Rs 1,950. Adjusted for the valuation of subsidiaries, the core business is available at 14.3x FY23E PE v/s its long-term one-year forward average P/E multiple of 22x. We maintain our Buy rating.
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