Key risks are delay in economic recovery, a sharp increase in commodity costs like steel and cement and a rise in working capital.
Improving share of low-payment risk orders and with potential deleveraging ahead, L&T is favourably placed in spite of near-term commodity headwinds; maintain ‘buy’ with an increased TP of Rs1,616, implying 19% upside. L&T has delivered strongest-ever quarter-on-order inflows (Rs732billion, +76% y/y) in 3QFY21 with a spate of order wins announced in January 2021, suggesting continued momentum. The cash flow outlook appears promising as well.
Core ebitda margins better than our estimates for 3QFY21; we view commodity cost impacts as transient: Core ebitda margin at 10.2% (+130bps y-y) was ahead of our estimate of 8.9%. Even adjusted for “others” segment where L&T had made a lumpy PAT gain of Rs3.4 billion through the sale of commercial real estate, ebitda margin was at 8.1% (marginally lower y-y) and 40bs ahead of our estimate. We view this core margin in a positive light as it was recorded at a time of sharp commodity price rise (+(9% y-y for steel, according to management). While domestic steel prices are at the peak (Rs55,000/t+ in January 21), we expect prices to moderate as demand supply imbalances correct over time.
We expect deleveraging and further improvement of net working capital (NWC) levels till 1HFY22F: L&T has already reduced its net debt level by Rs131 billion in 3QFY21 from FY20 levels. With collections from public sector orders being robust, we expect strong cash flows in 4QFY21 leading to further debt reduction. Management has guided for absolute NWC (ex-finance) being flat at Rs310 billion in FY21, which should lead to NWC to sales declining from 26.2% in 3QFY21 to ~25% by 4QFY21 and further to 22% by 1HFY22 on increased sales.
Potential pipeline of Rs2.65 trillion suggests further order inflows of Rs0.5 trillion in 4QFY21. This is based on historic win rate of tenders for L&T over the past five years and with increasing level of multi-lateral funding for orders, we are optimistic on cash collections in FY22F and beyond.
Trading at 16x FY23F EPS of Rs87; maintain ‘buy’ with higher TP of Rs1,616. We largely retain our EPS estimates for FY21-23F with minor changes. We value L&T on an SOTP basis on FY23F estimates to arrive at our new TP of Rs1,616, implying 19% upside, and maintain our ‘buy’ rating. Key risks are delay in economic recovery, a sharp increase in commodity costs like steel and cement and a rise in working capital.
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