Stock Review: Larsen & Toubro

Larsen & Toubro's June quarter results were in line with Street expectations. This helped its shares recover three per cent from its intra-day low on Monday. The stock finally closed at 1,629.85, a decline of `10 over its previous close as compared to a 1.8 per cent fall in the Sensex. Led by a strong order book and execution, the company reported a 21 per cent increase in revenues. These were driven by robust growth of 22-25 per cent in revenues from the engineering & construction (E&C) division, which accounts for about 85 per cent of the total, and the electronics business.

However, due to input pressures, visible across its three key businesses, operating margins fell 95 basis points, leading to slower growth of 12 per cent in net profit at `746 crore.

Analysts believe operating margins could remain under pressure for another one or two quarters but do not see major erosion, with commodity prices already cooling.

"In an environment where every other company is surprising on the downside, L&T's results, which are in line, are seen with a positive note. Our revenue and profits growth estimates (for L&T) remains at about 20 per cent and 15 per cent, respectively," says Abhinav Bhandari, analyst, Elara Capital.

The guidance looks achievable, considering that unlike other key players, L&T does not have major worries on revenue growth, given its strong order book of `1,36,172 crore (almost three times its 2010-11 revenues). Stable margins, good execution capabilities and less dependence on borrowed funds ensure better earnings visibility for the company. Analysts have a 'buy' rating on the stock and value it at `1,8502,000, based on the sum of part valuations.

ORDER WORRIES

The biggest and immediate worry remains the flow of new orders or the demand side, given that India Inc's capital expenditure cycle has seen moderation in the light of higher interest rates. The impact is already seen on engineering companies, with most of these having reported a decline in new orders. On a relative basis, though, L&T has scored well.

It reported a marginal three per cent rise in new orders at 16,200 crore, significantly lower than the trend seen last year, as well as the preceding quarter. However, the slowdown in order inflows has been an industry phenomenon recently, largely in the case of companies dependent on the flow of investments in the power sector.

L&T's order inflows, however, look better when compared to Bharat Heavy Electricals (BHEL) and Crompton Greaves, which reported a 77 per cent and 18 per cent decline in new orders, respectively in the June quarter. L&T did well, helped by two large projects in the building and road segment worth `6,700 crore. Consequently, its order inflow from infrastructure (part of E&C), 38 per cent of its order book, grew 50 per cent. New orders from the power segment grew just 22 per cent. However, again better as compared with BHEL.

BETTER THAN PEERS

Analysts believe a lot of new orders for upcoming power projects have been shifted towards the second and third quarter of the current financial year, given the macro headwinds. Despite these concerns, L&T and BHEL are relatively better placed in terms of revenue visibility, as their order books are three to four times their sales. Also, they have less dependence on international markets as compared to Crompton Greaves, which derives almost half its sales from abroad. For instance, in the first quarter, Crompton Greaves' international revenues took a hit on account of the unrest in West Asia and North Africa, and slowing demand growth in the European markets. For these reasons and the pressure of input costs, many analysts have downgraded their earnings estimate for Crompton.

For BHEL, except that the company reported a fall in order inflow, it has seen improvement in margins as a result of reduction in the cost of employees, on a 22.1 per cent growth in revenue. BHEL is expected to report about 20 per cent growth in profits in 201112 and is trading at reasonable valuations of 13 times its earnings estimate. Also, as the company is expanding its power equipment manufacturing capacity to 20,000 Mw by endFY12 compared to 15,000 mw currently, the benefits of scale will be felt in the coming years.