Larsen & Toubro: Designed to deliver

With proven execution capability, the company is a good proxy for the expected pick up in the capex cycle

Conservative investors could buy the shares of engineering and construction giant, Larsen & Toubro (L&T). At the current market price of ₹1,118, the stock quotes at reasonable valuations. Its trailing price-to-earnings ratio of 25 times is below the three-year average of about 30 times. On a one-year and two-year forward basis, it quotesat about 24 and 20 times respectively. Unlike some of the midcap stocks that have run up sharply, the L&T stock is up only 14 per cent over the last year.

The company provides the comfort of high revenue visibility, thanks to its large order book — 2.4 times its annual sales (FY17) — and its diversification across sectors and geographies. Moreover, with its strong balance-sheet and credible reputation to execute large-sized projects, it is well-positioned to benefit from the Centre’s infrastructure thrust. Investors will indirectly be betting on the fortunes of the Indian infrastructure sector and recovery in the capex cycle.

High revenue visibility

L&T has a large and diverse order book of about ₹2,62,900 crore. About 75 per cent of this is from the infrastructure sector, while hydrocarbons, power, heavy engineering and electricals and automation contribute 9 per cent, 5 per cent, 4 per cent and 1 per cent respectively. Domestic orders, which account for 73 per cent of the overall book, are increasingly driving the order inflows for the company. Domestic order inflows grew at 9.4 percent y-o-y during 2016-17 and a faster 12.1 per cent during the first quarter of 2017-18.

The management expects to improve its order inflows by 12-14 per cent during 2017-18, while its revenue is also expected to grow in about the same range (12-15 per cent). The company hopes to bag some of the big-ticket urban infrastructure and defence projects that are expected over the next one to two years; four landing platform docks for the Indian Navy, Mumbai Bandra-Versova sea link, Mumbai Trans harbour, Mumbai-Nagpur Expressway and Mumbai coastal road project.

International orders inflows have been down by about 4 percent during 2016-17. According to the management, ordering was weak in the West Asia region with finalisation of orders getting delayed in most of its projects. Its hydrocarbons and heavy engineering business segments are expected to have taken a beating on the back of low oil prices.

During the first quarter of 2017-18, international order flows were down by 40 per cent y-o-y; however, this time largely due to the base effect. During the first quarter of 2016-17, the company had bagged a $1billion order from Saudi Aramco for Hasbah field development..

However, the infrastructure thrust by the Centre is expected to compensate for the poor show in the international segment. For 2017-18, the Centre allocated about ₹4,00,000 crore towards infrastructure, especially transport infrastructure of roads, railways, waterways and civil aviation to build an effective multi-modal transportation system in the country.

Execution pick-up in infra

Moreover, after several quarters of muted execution, there are arguably signs of pick-up in execution of domestic projects.

Revenues from the infrastructure segment were up by 8 per cent y-o-y to about ₹52,900 crore during 2016-17. And there are initial signs of a pick up in order execution with revenues growing at a rapid clip of 16 per cent y-o-y during the first quarter of 2017-18. Transportation has been one of the largest growth drivers in the infrastructure segment, thanks to the Centre’s thrust on transport-based infrastructure projects. However, the operating margin in the infrastructure segment was down by 100 basis points to 10.2 percent during 2016-17 compared with the previous year. The management attributed it to delayed execution and extended stay on some of its projects. The company’s diverse sector exposure, however, helped it maintain margins at the consolidated level. During 2016-17, its operating margins were 16.6 per cent as against 16.4 per cent a year before. There was annual improvement in operating margins in most of the other sectors — hydrocarbons, power, hydrocarbons, IT and technology services, power, heavy engineering, electrical and automation; however margins were down for developmental projects and other segments.

Operating margins in the hydrocarbon segment improved from 0.6 per cent during 2015-16 to 6.8 per cent in 2016-17 on the back of larger order wins and operational efficiencies. IT and technological services, which have highest operating margins among all segments, managed to improve them further during 2016-17 to 21.2 per cent (as against 20.5 per cent a year back).

Healthy financials

During 2016-17, the company’s consolidated net sales grew 8.1 per cent y-o-y to ₹1,09,311 crore . In June 2017 quarter, growth was better at about 10 per cent.

Over the last ten years, revenue and net profit of the company have grown at a healthy CAGR of 14 per cent and 10 per cent respectively. Net profit was up by 40 per cent to ₹5,783 crore during 2016-17 compared with the previous year. It was led by high other income, lower interest cost and lower tax burden. In the June 2017 quarter, L&T’s net profit was up by 24 per cent y-o-y to ₹1,065 crore on the back of lower tax burden. The company’s debt-to-equity ratio was lower at 1.77 times as of June 2017 compared with 1.92 a year back .

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