Larsen & Toubro rating – Buy: Q4 performance was below estimates

Labour was 240,000 in March 2021, which L&T would have liked to ramp up to 275-300,000 in FY22E. (Bloomberg image)

Q4FY21 EBITDA was 5% lower than expectations given lower revenues. Low to mid-teens (13-17%) growth guidance for FY22e revenues and order flow with stable margins reflects realism on the 2nd wave impact and recovery optimism from it in H2. 36% dividend payout vs 32% y-o-y and reducing cash calls outside the core are in line with management commitment. We lower our FY22e-23e EPS by 3-8% to reflect 2nd wave impact and believe L&T is on a re-rating path.

Core working capital is 21% of sales v/s 23% y-o-y (19% in FY19): L&T’s cash flow from operations is up 3.4x to Rs 228 bn, vs an 11% y-o-y profit decline. Debtors are up 4% y-o-y and have been offset by advances on the bullet train project and better creditor days.

As payment terms gradually normalise, particularly post the 2nd wave impact receding, debtor days should move back to FY19-20 levels. Rs 18/sh final dividend is flat y-o-y and in addition to the Rs 18/sh special dividend announced earlier from E&A sale proceeds. Mgmt mentioned special dividend would be looked at from time to time as cash flow generation remains the focus and outside of Hyderabad Metro losses no incremental investments are foreseen beyond the core. Strategic plan to return to 18% ROE in the medium term is being worked on. This was last seen in FY11, and L&T was trading at 16-20x 1-yr forward EV/Ebitda then vs current 12.9x FY23e EV/Ebitda.

FY21 order flow down 6% y-o-y; prospect pipeline up 9% y-o-y: FY21 domestic order book is 79% vs 75% y-o-y. This augurs well for margins ahead as international projects tend to have lower margins. Infrastructure was the highest proportion at 59%, followed by services at 24% and hydrocarbon at 10%. Within infra, heavy civil works including the bullet train order were 34%, water+power T&D was 19%, transportation 12% and buildings and factories 10%. Q4 E&C margins were up 70 bps y-o-y at 12.8% and also higher than 12.5% in Q4FY19. E&C revenues were up 10% y-o-y.

Interesting pointers on outlook were Africa’s growing importance in the international business, Centre ensuring timely payments and confidence in the government’s drive to stimulate growth through capex. Labour was 240,000 in March 2021, which L&T would have liked to ramp up to 275-300,000 in FY22E. The 2nd wave has dampened the uptick here, but labour migration is nowhere close to 2020 levels.

Company’s strategic 5-year plan update should be watched for: Our only disappointment was when mgmt to our specific question mentioned divestiture of L&T Finance is not on their mind for now. Our FY23E Ebitda is lower by 5%, but the better cash flow generation led to the marginal upward revision in our SOTP-based PT to Rs 1,800 from Rs 1,745. We maintain 10x FY23E EV/Ebitda for core E&C (consol PB of 2.8x and 15.3 EV/Ebitda FY23E). Risks: (i) Mgmt not following prudent capital allocation; (ii) Government infrastructure spend not reaching pre-COVID levels and growing.