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 prioritise Balance Sheet strength over growth during the pandemic. While the second wave brought on similar challenges as FY21, construction activity was allowed to continue. Hence, the impact was much lower than that seen in FY21.
Labour availability no longer poses a challenge, with the current strength at 235k (v/s the peak requirement of 250k). Mgmt 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 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 Rs 8.9 trn. This is encouraging, but faster conversion into final awarding holds the key. The order book is strong at Rs 3.2 trn, with the book/sales ratio at 3.2x.
Catalysts to watch out for: Over the next two years, we see multiple catalysts emerging, including: (i) asset monetisation for Hyderabad Metro and Nabha Power; (ii) FCF of $1.5-2 bn p.a. in the core business; (iii) improvement in order inflows prior to polls, and (iv) improved execution, aided by a better working capital cycle, as the government focuses on capex. 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. So far, weak order inflows have impacted the stock’s performance, but will gain momentum once 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 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 Buy.