Larsen & Toubro (L&T) reported below estimate revenues following weak project execution in domestic power and metal projects (domestic sales down, 8 % year-on-year). Despite reduction in raw material +sub-contracting charges, (down 50 bps y-o-y ) and other opex (down 30 bps y-o-y), Ebitda margins dropped 60 bps y-o-y, due to higher staff costs (up 140 bps, y-o-y), due to headcount additions and salary hikes. While the management maintains FY14 revenue, margin and order intake guidance, we cut our FY14e & FY15e (standalone) earnings by 6% each, with a revised target price of R1,083 (assigning a lower PE of 15.8x to FY15e EPS).
Our earnings cut is led by lower margins owing to sharper-than-expected margin drag in shipbuilding & heavy engineering and increase in interest cost. We retain our revenue growth assumptions given the strong order book and back-ended billings (H2FY14e, mainly in infrastructure, hydrocarbons).
Power, ship-building, heavy engineering a drag on earnings: Customer-centric delays in the power segment (sales down, 44 % y-o-y, Ebitda down 35% y-o-y) coupled with a loss in ship-building (due to sales reversal of R1.15bn in Q1FY14) and a sharp fall in heavy engineering margins (down 1730 bps y-o-y on high base with 27 % y-o-y dip in Ebitda) impacted overall Ebitda for L&T (down 60 bps y-o-y, ex forex). This was despite margin improvement in the infrastructure sector (+30 bps y-o-y).
Key highlights
OB (order book) growth driven by transportation and hydrocarbon: L&T reported a strong 28 % y-o-y growth in order intake to R250 bn, led by large value tickets in dedicated freight corridor and Middle East hydrocarbon jobs. Order book grew at 8 % y-o-y to R1,654 bn, with 67 % coming from the infrastructure segment, 6 % from hydro-carbons, 10% from power, 9 % from metals and mining and balance 8 % from heavy engineering, ship-building.
Forex loss at R2.0bn vs R2.67bn; Of the total forex loss of R2.0bn in Q1FY14, R1.0bn was included in other opex, which for Q1FY13, stood at R2.67bn, with R1.0bn included in other opex.
Order cancellation of R6.0bn in ship-building; Katupalli in focus: L&T saw cancellation in orders from the ship-building segment, which impacted Q1FY14 revenues for ship-building. The management targets to scale down operations at Hazira and will load more jobs at the Katupalli fabrication and ship-building yard to improve utilisation levels.
Sharp rise in employee costs to 9.3%: L&T added 4,400 employees during Q1FY14(+ 8 %), which coupled with compensation revision led to a sharp rise in salary cost by 24% y-o-y to 9.3% of revenues. L&T expects salary costs to stay at 7 % of sales in FY14e.
Hydrocarbon business update: L&T witnessed a sharp dip in hydrocarbon margins due to a higher proportion of export jobs and rise in salary costs in this division due to hiring of expats who are in the high salary bracket.
Dhamra loss at R1.7bn in FY13; Utilisations set to improve: Dhamra Port?s total loss stood at R1.7bn for FY13. L&T expects utilisation levels to improve from 11mt in FY13 to 15-16mt in FY14e for Dhamra.
Project pipeline in power weak at 5-6 GW: Led by select SEB (state electricity board) and government sector, L&T expects this year project pipeline to remain subdued at 5-6 GW.
Overseas debt at R80 bn: Total debt from overseas for L&T stood at R80bn against a total debt of R110 bn during the quarter. L&T has unhedged debt of around $250-300m overall.
Domestic revenue growth holds the key; guidance reiterated: We maintain that a revival in domestic execution for L&T remains a key to margin improvement. The management expects the revival in H2FY14e, led by execution in infrastructure. The management reiterated its FY14e revenue guidance of 15%, flat E&C (engg & constrcution) margins and 20 %+ order inflow guidance.
Outlook and valuations: Despite a weak set of numbers, we remain positive on L&T in the medium- to long-term view given its best positioning in the domestic industrial-infrastructure space both in terms of strong order book and revenue scalability potential. We maintain most concerns for L&T like working capital and OPMs (operating profit margins) are cyclical, and not structural with a potential to improve over two-three years. We maintain our Buy/SO (sector outperformer) rating with a revised sum-of-the-parts valuation of R1,083(earlier ?R1,231, ex-bonus).
