Guidance aggressive; valuation fair
■ Expect margin pressures to continue. Led by a slowdown in industrial and
infra capex in India, we expect L&T to source 40% of its FY14/15 order flows
from the Middle East (M-E) and real estate segments. Four factors lead us
to believe that this should impact its margins: (1) historically L&T’s margins
have fallen with a rising share of orders from these segments, (2) real estate
orders are prone to delays, have a longer debtor cycle and impact PBT
margins, (3) its M-E entities have historically earned just 5-8% margins, and
(4) Korean E&C majors, with high M-E exposure, too, face margin pressures.
■ Order flow growth guidance likely to be missed. Based on our bottom-up
analysis, we expect L&T to deliver 11% (vs. guidance of 20%) order flow
growth during FY14. We believe at least 50% of its order flows are from
business segments that are impacted from sector-specific issues; which are
unlikely to be resolved soon. Thus, contrary to the common perception, an
expected easing in the interest rate cycle is unlikely to result in any
meaningful recovery of the investment cycle, in our view.
■ L&T has a poor track record of meeting its guidance. Over the past
decade, L&T has disappointed on at least two out of three parameters of its
guidance for seven years. Its margin guidance has mostly been missed.
Over the past few years, its guidance at the start of the year has been driven
by the hope of a capex recovery. This has proven optimistic leading to the
guidance revised down during the year.
■ But valuation derating likely to be gradual. L&T trades at 14x one-year
forward standalone earnings which appears expensive for muted 10% EPS
CAGR over FY13-15E. But, we believe its derating is likely to be gradual as
it would take time for the deteriorating order book mix to translate into weak
earnings. But, we do not rule out the possibility of few more orders turning slowmoving or dormant, which could lead to a stock correction. Maintain NEUTRAL.
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■ Expect margin pressures to continue. Led by a slowdown in industrial and
infra capex in India, we expect L&T to source 40% of its FY14/15 order flows
from the Middle East (M-E) and real estate segments. Four factors lead us
to believe that this should impact its margins: (1) historically L&T’s margins
have fallen with a rising share of orders from these segments, (2) real estate
orders are prone to delays, have a longer debtor cycle and impact PBT
margins, (3) its M-E entities have historically earned just 5-8% margins, and
(4) Korean E&C majors, with high M-E exposure, too, face margin pressures.
■ Order flow growth guidance likely to be missed. Based on our bottom-up
analysis, we expect L&T to deliver 11% (vs. guidance of 20%) order flow
growth during FY14. We believe at least 50% of its order flows are from
business segments that are impacted from sector-specific issues; which are
unlikely to be resolved soon. Thus, contrary to the common perception, an
expected easing in the interest rate cycle is unlikely to result in any
meaningful recovery of the investment cycle, in our view.
■ L&T has a poor track record of meeting its guidance. Over the past
decade, L&T has disappointed on at least two out of three parameters of its
guidance for seven years. Its margin guidance has mostly been missed.
Over the past few years, its guidance at the start of the year has been driven
by the hope of a capex recovery. This has proven optimistic leading to the
guidance revised down during the year.
■ But valuation derating likely to be gradual. L&T trades at 14x one-year
forward standalone earnings which appears expensive for muted 10% EPS
CAGR over FY13-15E. But, we believe its derating is likely to be gradual as
it would take time for the deteriorating order book mix to translate into weak
earnings. But, we do not rule out the possibility of few more orders turning slowmoving or dormant, which could lead to a stock correction. Maintain NEUTRAL.
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