A quick view on Q1FY19
L&T reported YoY revenue growth of 18.8% to INR282.8 Bn (consolidated) during Q1FY19 over corresponding period the previous year. The revenue growth was mainly driven by strong performance in Financial Services (L&T Finance Holdings), Hydrocarbon & IT Services (L&T Technology Services & L&T Infotech). These segments reported a YoY revenue growth of 33.3%, 37.9% and 30.8% respectively. Infrastructure, which accounts for ~50% of the total revenue reported YoY revenue growth of only 8.8%; however, management stated that the order inflow from infra is strong and could gain momentum in coming quarters. Other segments, who witnessed good traction are – Development Projects (YoY growth of 22%) and Defence Engineering (YoY growth of 35.5%); however, their revenue contribution is low.
EBITDA reported YoY growth of 16.2% to INR45.7 Bn and EBITDA margins improved by 158bps YoY during the quarter. In-line to the operating performance, Net Profit reported YoY growth of 13.8% to INR12.1 Bn and Net profitability witnessed the marginal deterioration of 19bps during the quarter.
The company has a current order book of INR2.72 Tn and order book to TTM revenue (excluding revenue from IT & Finance) is 2.6x, giving visibility for the next 2-3 years. L&T is getting orders from both domestic and overseas market. Domestic business is performing on defence and infra push by the government while improving crude prices provided good support to orders from the Middle East.
Infrastructure: Gaining momentum after a weak period, significant transformation expected
L&T is getting most of the EPC based on City Infra and Railway projects, which is fuelling Infrastructure order book. Execution is the key issue and thus, despite a significant jump in order inflow, the company reported only 8.8% revenue growth in this segment during Q1FY19. We believe that execution delay could have happened due to regulatory issues from local authorities, rather than L&T’s side, which is just a short-term hiccup.
Government is focusing on Smart City Projects and thus developing selected urban areas in all the states. We are expecting significant investment is city infrastructure space and most of the focus would be on metro rail projects, road infrastructure and water treatment plants. The government allocated financial support to city infra to the extent of USD7.77 Bn (for the period of FY15-20). Except for water treatment, L&T has a strong presence in the other two areas and it is the preferred player for the government projects. Therefore, we are expecting a consistent flow of orders to L&T in infrastructure space.
Heavy Engineering (including Defence) and Hydrocarbon are consistently expanding their shares in Order Book. Power is the one which would continue to struggle, according to us
- Despite slower than expected improvement in the industrial sector, HE is performing well as orders from Defence are gaining traction due to government initiative on Public-Private Partnership (PPP) in defence to promote in-house manufacturing (Make in India). We believe that the defence would continue to perform well due to a revival in defence policy to reduce the high cost of imports. L&T is the main partner in many of the defence deals such as the development of Howitzer Artillery, Diesel Electric Submarines and Akash Missile Air Defence Systems. All these are key defence projects and ministry is working closely with companies to finish it in deadlines.
- The rise in crude oil prices, after touching the low of USD30 per Barrel, has improved the economic conditions in the Middle East and North African region (MENA). Middle East is the key market for L&T due to its expertise in Hydrocarbon space. We believe that even if the Crude prices remain at current level, L&T would continue to bag international orders from this space and weaker INR could also provide better FOREX gain in short to mid-term.
- Order book from Power is struggling due to – 1) Most of the power projects are under RBI scanner and termed as NPAs and 2) Government’s focus on renewable rather than any significant expansion in thermal power projects.
L&T is firing on all cylinders
Construction (Metro projects, city infra and real estate are getting good traction), Financial Services (L&TFH will get rural boost), Hydrocarbon (due to rise in oil prices), Infrastructure (due to growth in domestic orders) and IT (both service and product business is doing well) are performing well. Almost firing on all cylinders. Management mentioned that the Government thrust on infrastructure projects compensated the slowdown in overseas market and thus Infrastructure, which is the largest contributor to revenue, has been improving and on track. Key segments are performing well.
Working capital to sales, which was at 25% in FY16, came down to 21-22% in FY17 and ended FY18 at 19%. Though it marginally went up to 20% in Q1FY19; however, the company is targeting it to reduce to 18% in FY19 (mentioned in the meet). Balance sheet health is improving.
L&T is selling Electricals & Electronics (also known as Electricals & Automation) to Schneider Elec and Temasek for INR140 Bn. First, the segment was not performing and; Second this deal would help in paying the standalone debt of INR97 Bn. A weak segment will go out and remove debt & interest burden.
Holding company discount and SOTP method of valuation:
Sum of above mentioned non-core subsidiaries is INR 31,200 Cr
The company has a Hydrocarbon business, which we could value at 1.0x Price to Sales. The TTM sales of the division are INR 12,700 Cr and thus we would value it at INR 12,700 Cr. With this, the total value to subsidiaries would be INR31,200 Cr + INR12,700 Cr = INR43,900 Cr.
The current market value of L&T is INR184,000 Cr, and after deduction of the value of major subsidiaries from the total market cap of L&T, then the residual value would be INR184,000 Cr – INR43,900 Cr = INR140,100 Cr (the residual market cap)
TTM standalone profit of L&T is INR5,740 Cr (at the end of Q1FY19) and the P/E would come at TTM 24.4x (INR140,100 Cr divided by INR5,740 Cr), which is a moderate valuation on the standalone number.
Therefore, at 50% holding company discount on IT & Finance, 1.0x Price/TTM Sales to Hydrocarbon business and 24.4x value to L&T standalone numbers, the current price is moderately valued. It reflects that there will be very limited chance for rerating in valuation multiples and the stock price would move only on financial performance, which is expected to be better