The stock of Larsen and Toubro (L&T) has been a surprise winner, gaining over 22 per cent year-to-date, much ahead of BSE Sensex's 12.5 per cent. This is despite a lacklustre December quarter show. However, interestingly, the Street is willing to put all the disappointments behind and look at the bright side of the company.
"L&T today has reached a certain scale that it would be unfair to see the company expand its order book by 12-15 per cent year-on-year hereon, given its base effect and the operating conditions, which haven't turned totally favourable yet," a fund manager invested in the stock explains.
Therefore, he believes that what analysts would closely monitor is whether L&T is taking the right steps to reduce its working capital ratio and monetise its non-core assets. Analysts at Jefferies, who recently upped their 12-month target price on L&T to Rs 2,000 (nearly 20 per cent upside), say that the company has begun the process of improving its return ratios from the FY16 bottom. "Management focus on reducing working capital and asset monetisation should yield results in 12-36 months. We believe L&T will see additional benefits from macro tailwinds of industrial capex announcements in FY18," the analysts add. Adding support to Jefferies, another foreign brokerage, Nomura, asserts that over the past 15 months, there have been visible efforts by L&T to focus on profitability along with growth versus its earlier skewed focus on order inflows. "We believe the company is walking the talk on its five-year strategy," the analysts point out. For Nomura, L&T is among the top picks in the India Industrials space.
These moves on divestment and the recent reduction in working capital ratio (working capital as a percentage of revenue) have urged analysts to believe that it is on a proper course correction mode. In FY16, the initial public offering in L&T Technologies and L&T Infotech along with a few smaller stake sales, such as the Kattupalli port, should boost the return on equity (RoE) from about 10 per cent in FY16 to 11.5-12 per cent in FY17. Nomura feels that sustained efforts to reduce non-core assets exposure may further elevate the RoE to 14 per cent by FY19. Not just that, the working capital ratio has also declined from 24 per cent in FY16 to 22 per cent so far in FY17.
On the whole, L&T's deliberate shift from owning assets to functioning as an EPC (engineering, procurement and construction) and annuity contractor supports its long-term plans. The sore point in the near-term is the capital tied up in the Hyderabad metro rail project. However, improved order flows from hydrocarbon projects, smart cities and a gradual recovery in heavy engineering projects should compensate for this blip. Overall, ordering momentum has also somewhat improved, though a sharp turnaround is still elusive as private capex remains dry.
For now, 10-15 per cent annual revenue growth is the target the Street has for L&T. But, will the company keep up with it will be known in a few weeks.
