Larsen & Toubro
9 December 2019
Bracing for macro headwinds
Cut FY20/21 core EPC estimate by 1.5%/3.4%; Valuations provide comfort
Order inflow assumption trimmed on account of macro risks:
revisited our order inflow assumption to factor in risks of capex cuts and the
likely delay in order awarding from the Maharashtra government post the
change of government in the state. L&T’s sensitivity to the cut in Central
government capex is quite limited as it forms just ~20% of the order book, with
limited contribution from roads, railways and defense. Our overall order inflow
assumption stands at 9.6%/10.8% for FY20/FY21 with core E&C order inflow
growth estimated at 5.2%/8.8%.
2HFY20 ask rate for core E&C is at 2.2%.
Minor near-term hiccups in execution may not be ruled out:
economic slowdown and the general elections, L&T’s core E&C domestic
business has witnessed growth of 16% in 1HFY20. However, we recall that
~INR160b worth orders pertaining to Andhra Pradesh and the Mumbai Coastal
Road project are slow-moving currently. Additionally, we suspect near-term
slowdown in construction activity in Maharashtra state owing to state elections
and delay in formation of a new government. Due to lower order inflow
assumption and near-term risks to execution, we lower our FY19-21E revenue
CAGR to 12.4% from 14.1% earlier.
2HFY20 ask rate for core E&C is at 12.8%.
But, L&T is better off navigating concerns compared to peers:
Thanks to L&T’s
well-diversified business across verticals as well as geographies, it is in a better
position to overcome macro challenges compared to mid-cap EPC companies
dependent on any single segment or geography. For instance, post the
formation of a new government in Andhra Pradesh, uncertainty around the
choice of the capital city had a negative impact on NCC (not rated), while the
impact on L&T was quite limited.
Conclusion of E&A sale deal and return of cash to shareholders can re-rate
We expect the conclusion of the E&A sale to happen in 4QFY20. This
would result in gross proceeds of INR140b to the company. With no major
capex and aversion to capital allocation in the asset business, there is a high
likelihood that L&T may announce special dividend to return excess cash to
shareholders, especially as the new tax rules for buyback has made it
redundant for the company to choose between the two options. Any such
announcement in 4QFY20 can be a re-rating catalyst for the stock. Additionally,
any improvement in the macro environment would be beneficial for the stock.
Valuation and view:
We cut our core E&C EPS estimate by 1.5%/3.4% for
FY20/FY21, incorporating lower order inflow/revenue growth assumption.
Consol. EPS has been cut by 1.3%/2.6% for FY20/FY21. We have also lowered
our target P/E multiple on core business to 20x from 22x on account of macro
uncertainties. Accounting for the current market price of listed subsidiaries,
our TP stands at INR1,680 (prior: INR1,830). Adjusted for the valuation of
subsidiaries, the stock trades at FY20/FY21E P/E multiple of 19x/15.6x v/s its
long-term trading average P/E multiple of 23x. Maintain
Equity Shares (m)
52-Week Range (INR)
1, 6, 12 Rel. Per (%)
12M Avg Val (INR M)
Free float (%)
1791.9 / 25.2
1607 / 1202
Financials Snapshot (INR b)
Shareholding pattern (%)
Sep-19 Jun-19 Sep-18
FII Includes depository receipts
Stock Performance (1-year)
Larsen & Toubro
Sensex - Rebased
Nilesh Bhaiya – Research Analyst
(Nilesh.Bhaiya@MotilalOswal.com); +91 22 6129 1556
Pratik Singh – Research Analyst
(Pratik.Singh@MotilalOswal.com) +91 22 6129 1543
Investors are advised to refer through important disclosures made at the last page of the Research Report.
Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.