In the third quarter, L&T’s core engineering and construction business faced challenges in its operating performance, while order inflow saw a significant 25% increase, driven largely by export contracts. This mixed performance reflects the company’s resilience amid market fluctuations and external factors, setting the stage for strategic adjustments in the upcoming quarters.
L&T Shares Reach 52-week High Before Dipping on Disappointing Q3 Performance
L&T, the renowned engineering giant, witnessed a surge in its stock price to a 52-week high of ₹3,737.90 per share following significant new order wins. However, the enthusiasm waned the next day as the third-quarter operating performance of the company’s core engineering and construction (E&C) business failed to meet expectations.
The operating margin experienced a 90 basis points decline year-on-year, settling at 7.6%, falling short of analysts’ projections. The weak core margin was attributed to the execution of legacy orders secured in FY21 and the first half of FY22, alongside the new orders that did not achieve a margin recognition threshold.
Over the past three quarters, the E&C margin has consistently remained in the low single digits, signaling ongoing challenges. L&T has adjusted its E&C margin guidance range to 8.25-8.5% from the previous 8.5-9%, triggering profit-booking and a subsequent 4% decline in stock value.
The company has progressively entered into more fixed price contracts, accounting for 42-43% of its order book in the first nine months of FY24 compared to the traditional level of 33-35%. However, such contracts bring about higher margin volatility, especially amidst commodity inflation, which has contributed to the overall margin pressure.
Looking ahead, L&T anticipates concluding the legacy contracts by FY24, paving the way for a higher share of new orders with improved margins in FY25. With a focus on achieving a double-digit margin, the management foresees a gradual improvement in core Ebitda margin over the next few quarters.
Priyankar Biswas, an India analyst at BNP Paribas, believes that the persisting overhang of legacy projects may extend into H1FY25, but newer projects crossing the margin recognition threshold could lead to a normalized core Ebitda margin beyond that period.
The company is banking on a larger portion of revenues from its real estate business, known for its high margins, in FY25 and FY26 to further fuel margin recovery.
Despite a positive order inflow growth of 25% year-on-year amounting to ₹76,000 crore and a 22% increase year-on-year in the order book reaching around ₹4.7 trillion, concerns regarding margin overshadowed the Q3FY24 earnings. Notably, while domestic order inflows fell short, international orders saw a significant upsurge, particularly in West Asia, with Saudi Arabia constituting nearly 29% of the total order book.
L&T’s progress in securing new orders and its strategic focus on improving margins position it for potential recovery and growth in the coming quarters, underlining its resilience in navigating the evolving market dynamics.
L&T’s Order Book Strength Signals Growth Potential
Larsen & Toubro Ltd (L&T) has strengthened its growth outlook for the current fiscal year, with an upward revision in revenue guidance and a considerable surge in order inflow projections. Bolstered by a robust order book, the company has raised its revenue growth guidance to high-teens from the earlier 15% for FY24. Additionally, the anticipated order inflow growth has been adjusted to 20% year-on-year, as opposed to the previous projection of over 12%. This optimistic outlook is supported by L&T’s substantial pipeline of prospects amounting to approximately ₹6.3 trillion in the near-term, signaling promising revenue visibility.
Market Performance and Government Support
Over the past year, L&T shares have experienced a notable ascent, marking a 64% increase. This upward trajectory can be attributed to the government’s emphasis on infrastructure capital expenditure, which has positively impacted the order prospects of key capital goods companies and boosted market sentiment towards their stocks.
Near-Term Risks and Valuations
Despite the overall positive outlook, L&T’s management has highlighted near-term risks, particularly pertaining to potential election-related slowdown impacting domestic order execution and inflows for the upcoming quarters. Additionally, although there are indications of a revival in private sector capital expenditure, the full recovery of this segment remains pending.
Furthermore, while the company’s order book strength remains a positive factor, concerns regarding valuations have surfaced. Analysts at Kotak Institutional Equities have remarked on L&T’s stock trading at a relatively high multiple, with the current one-year forward core E&C earnings-per-share multiple at 33x, compared to the brokerage’s 22x multiple. The report dated 31 January from Kotak Institutional Equities emphasized the challenges posed by the expanding share of overseas business, the increasing shift towards fixed contracts, disappointments in domestic ordering, and the projected case for fiscal consolidation from FY2025.
Downside Risks for L&T Investors
In addition to the aforementioned factors, there are potential downside risks that investors in L&T should remain vigilant about. These risks include the possibility of slower completion of mega and ultra-mega projects, input cost inflation, elevated receivables, and potential delays in the monetization of non-core assets.
In conclusion, while L&T’s order book strength and revised growth projections offer an encouraging outlook, it is imperative for investors to carefully monitor both the near-term risks and the broader market dynamics to make informed investment decisions.
