CLSA:: Larsen & Toubro :: Weak orders; strong execution : Outperform

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Weak orders; strong execution
L&T’s 3QFY11 recurring net profit rose 33%YoY to Rs8.1bn – ahead of
expectations. E&C execution grew 45% YoY as long lead power projects entered
revenue recognition. While margins declined by 60bps QoQ, 9M margins are flat
YoY. Order-flows declined 25% YoY on weak public sector ordering (-56% YoY).
New order guidance of 25% for FY11 is subject to bunching up of large public
sector orders in Mar’11. While order flow miss for FY11 is likely, we believe that
same is a timing issue and may lead to spill over to FY12. A 3 year backlog, strong
execution and stock correction provide a good entry point. Maintain O-PF

Strong pick up in E&C execution
L&T reported a 45% rise in core E&C revenues to Rs98.7bn, strongest in last 7
quarters. Long lead power projects (BTG orders) entering revenue recognition and an
increased rate of implementation in infrastructure orders have led to the growth. 9M
E&C  revenues  are  now  up  22%  YoY,  ahead  of  management  guidance  of  20%  YoY
growth. Electrical segment revenue growth at 11% and MIP at 15% were largely inline.
Ebitda margins decline not a major concern
Overall Ebitda rose a slower 23%YoY to Rs12.4bn as a decline in E&C margins of
175bps YoY partially offset the gains from rising revenues. The decline is partly on
account of rising commodity prices and partly on temporary mismatch between margin
and revenue recognition. Electrical and MIP businesses alse reported a 140bps and
94bps respective decline in margins. Overall Ebitda margins are flat YoY for 9MFY11
and management guides same for the full year as rising raw material price impact will
largely be felt with a delay. We build in flat FY11 and a 40bps decline in FY12.
Public sector ordering major disappointment; 4Q bunch-up seen
E&C order-flows declined 29%YoY in 3Q to Rs118bn as delayed public sector ordering
(down 56% YoY 3Q, 44% 9M) and no internal orders countered the strongest ever
export ordering. Backlog declined (Rs1,125bn as of Dec-10), pulled down by c.Rs50bn
in order cancellations and re-scoping – largely in the commercial real estate segment.
9M E&C order-flows are up only 6%YoY (domestic orders flat YoY). Management’s hope
of meeting its 25% YoY order inflow guidance now hinges on a revival/year-end target
meeting by public sector entities. The same though implies Rs350bn in 4Q ordering but
large pending internal order booking (Hyderabad metro, Rs150bn gross) may bring the
number required for external order booking inline with last year’s (Rs221bn).
Improved risk reward but near term newsflow remains a concern
Post 15% correction last month, L&T trades at 18x FY12 earnings; least in last two
years offering an attractive  entry point. L&T’s superior execution is now visible and
value unlocking of the strategic subs remains on-track, with L&T finance IPO planned
for 4Q. Delayed project awards, approval  related issues and raw material costs
concerns remain near-term headwinds and the same getting addressed will be key.