L&T rating: Buy with revised target price of Rs 1,826

While the revenue decline is deeper than our estimate, we reckon the 9–10% decline in guidance for FY21 implies a 2% CQGR for the remaining quarters, which is encouraging.

L&T Technology Services (LTTS) reported a dollar revenue drop of 12.5% q-o-q in Q1 FY21 versus our estimate of a 9.5% decline. EBIT margin dipped to 12.1%, much below our estimate of 13.3%. Revenue contraction is attributable to a sharp q-o-q decline of 22.8%/24.2% in the transportation/plant engineering (PE) business overwhelming the robust 9.2% q-o-q growth in medical devices. Management guided for a 9–10% dip in FY21 topline, along with a potential recovery in growth and margins from Q2 itself. This implies a 2% CQGR for the remaining quarters of FY21. While we remain bullish on the long-term prospects of the fast-growing ER&D and believe LTTS is in a pole position to benefit thereof, the current quarter miss leads to a marginal cut of 3.5/2.5% in FY21/22E EPS. Maintain buy with a revised TP of Rs 1,826 (versus Rs 1,872 earlier; 20x FY22E) at 20x FY22E EPS.

Covid-19 hits plant engineering and transportation hard: The 12.5% q-o-q drop in revenue, although steeper than our estimate, is not scary as the bulk of damage arose from transportation/PE (down ~22.8/24% q-o-q)— hit hard by the pandemic as factories remained largely closed with limited activity. While the revenue decline is deeper than our estimate, we reckon the 9–10% decline in guidance for FY21 implies a 2% CQGR for the remaining quarters, which is encouraging.

Rationale for margin miss: Capacity retention for future execution Ebitda margin eroded 260bps q-o-q to 15.9%, largely due to a 670bps q-o-q fall-off in gross margin that was somewhat offset by lower SG&A expenses. The plunge in gross margin is attributable to an almost 800bps q-o-q drop in utilisation, which management attributed to their decision to maintain capacity for future execution.

Outlook and valuation, weak numbers, improving outlook: Uncertainty continues to mar the outlook for ER&D revenue growth, now further undermined by the Covid-19 crisis. We believe unlike IT services wherein higher online activity has been a saviour of demand, ER&D business growth hinges on plant operations and transportation (aviation etc). While the numbers did miss our estimates and a marginal cut in inescapable, we believe bounce-back will be sharper than management guidance, although lockdowns in case of a second wave of the virus remains a key risk. Retain buy/SO with a revised TP of Rs 1,826 (earlier Rs 1872 20x FY22E).