Beyond a solid order book, L&T has assets to get rid of

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MUMBAI/BENGALURE : Larsen & Toubro Ltd (L&T) December quarter (Q3FY22) results are a mix of ups and downs. Total order intake fell 31% year-on-year (yoy) to around 50,400 crores with domestic orders remaining weak, falling 52%. The international orders segment, however, was robust, with growth of 95%.

“The drop in orders in the domestic market is mainly due to the high base of the Mumbai Ahmedabad high-speed rail project received last year,” L&T management said in a conference call with analysts.

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Strong order book

Still, it helps that the outlook is strong. L&T’s total backlog increased 3% year-on-year to 3.4 trillion, with domestic orders contributing 76%. For Q4FY22, the order outlook is 3.9 trillion, the highest in recent years. The outlook for domestic orders is 3 trillion of the total order backlog, with international orders around 89,000 crore, according to management. “The fourth quarter will likely be a busy quarter with multiple order completions,” management said.

Management pointed out that despite decent bidding activity, award finalizations in the domestic segment were somewhat muted in the third quarter. The auction/tender ratio was around 40% in FY9MFY22, compared to 61% the previous year. On the international front, management expects good traction from the Gulf countries for the infrastructure and hydrocarbon segments.

L&T maintained its low to mid-teens revenue growth forecast for this fiscal year. Among the brakes, cost inflation continues to weigh on profitability. Consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) margins fell 50 basis points (bps) to 11.5% in Q3 from 12% a year ago. One basis point equals 0.01%.

Better overhead recoveries, project mix and value engineering helped offset the pressure of high raw material costs to some extent. That said, as around 65% of its total order backlog is in fixed-price contracts, management cautioned that a sharp rise in input costs can weigh on margins.

That aside, exposure to non-core assets, primarily the Hyderabad Metro and Nabha power projects, was a sore spot for L&T investors. The sale of these assets is essential for L&T to reduce its debt and move towards an asset light model.

Here it is helpful that the Hyderabad project, seen as the next likely candidate for divestment, saw improved footfall and operational turnaround in the third quarter. However, it remains in deficit. In addition, L&T is targeting a sale of 51% of the shares in the Nabha power project and is optimistic that the sale could be completed within a year or two.

However, investors may need more conviction. “While Hyderabad Metro ridership has improved, unless a clear timeline on its divestment is shared, this would remain a concern for investors,” said an analyst at a national brokerage asking anonymity. “Similarly, the Nabha project, which has been stalled due to carbon neutrality concerns, may take longer than expected to find buyers,” he said.

To be sure, L&T shares are down 8.7% from their 52-week highs on Jan. 18 on NSE. In an initial note, analysts at Reliance Securities Ltd said that while an expected pick-up in order activity and a strong improvement in order intake may boost the stock’s performance over the medium to long term, consumption cash flow in the Hyderabad metro project and higher input costs are the major short-term overhangs. “Sound execution, expanding base margins, prudent capital allocation and improving yield ratios are expected to drive a compound annual growth rate of approximately 27% in earnings in FY21-24E “said analysts at Dolat Capital Market Pvt. Ltd in a January 29 report.

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