Expect 60-70 bps decline in L&T margins: Kotak Securities

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Infrastructure major Larsen & Toubro is expected to post its results today, but Sanjeev Zarbade of Kotak Securities is not too optimistic. "We are seeing a clear slowdown in the overall capital expenditure cycle, so we need to keep a close eye on project execution and their working capital cycle," he explained to CNBC-TV18.

Zarbade also says that the rise in the steel prices over the quarter will put a pressure on margins. "We are forecasting close to 60-70 bps decline in margins on YoY basis," he said.

Also read: L&T Q2 total income seen up 18% at Rs 11006 cr

Currently, Kotak Securities maintains an accumulate view on the stock, recommending investors to buy at dips.

Below is an edited transcript of his interview. Also watch the accompanying video.

Q: What are you expecting from the numbers and more importantly can the FY12 order guidance be maintained?

A: That is quite a tricky question because it is not just about the order guidance but there are other issues also which need to be looked at, basically the project execution as well as the deterioration in the working capital cycle. These are the two main issues which also need to be monitored.

If you look at the overall backdrop, we have seen that in the first five months of the current fiscal, starting from April to August, the overall project investments announced there has been a drop of close to 40-45% on a year-on-year (YoY) basis and the drop is just not in terms of overall project cost but even in terms of number of projects that have been announced. So there is a clear slowdown that we are seeing in the overall capex cycle.

Even the RBI in its bulletin has indicated that for the current fiscal the overall capex would be lower than in previous fiscal. So that is the backdrop in which L&T is operating. So we are not expecting much from the way the order intake is expected to pan out. It remains to be seen whether they are able to reach the order intake guidance.

Q: I think they have a decent backlog with respect to orders, so even if perhaps the capex situation improves over the next 12-18 months, L&T may not be hurt. Therefore, would you say the stock would remain largely unharmed irrespective of the order announcement?

A: I don't think so because these are very long gestation projects so definitely they would get help from the strong order backlog that they are having, that would take care of the revenues in the current year and probably even in the next fiscal.

But beyond that, unless they are able to grow their order intake by a sizeable proportion, the growth beyond that would definitely be under concern. So the order intake remains to be monitored strongly.

Q: What about margins itself? What are you expecting them to do?

A: I think margins would be close to same range; material prices have not moved much, the steel prices have definitely softened but YoY basis steel prices are still up close to 20%.

Given this backdrop, I think the company which had guided close to 50 basis point decline in margins at the beginning of the year they would end up in the same range. We are forecasting close to 60-70 bps decline in margins on YoY basis.

Q: Where are you in terms of price on the stock, where do you see the valuations because it has underperformed quite a bit in the last three months?

A: We are in the process of working out the overall price. We will wait for this quarter's numbers when it will be announced to come out revised price guidance. But definitely the way the capex cycle is going on and most capital goods companies are finding it difficult to get order intake, the under performance was largely expected

Q: Is it a buy at current price?

A: We are recommending accumulate, wherein we are indicating investors to buy into declines.

Q: What about the rest of the pack? Do you track Crompton Greaves proactively and do you have call post the numbers?

A: We also cover Crompton Greaves ; we attended the analyst meet yesterday. We were disappointed with the numbers, they way the numbers panned out and quite disappointed with the overall margins picture. We have a reduce rating on the stock.

Q: On EPC contractors what is your top picks?

A: We are largely cautious on engineering, procurement and construction (EPC) contracts. In fact, within our overall coverage universe, we like products companies right now than EPC companies.

Within that, we are recommending Cummins India Limited , Greaves Cotton and Bharat Electronics . Both Cummins and Greaves Cotton are products companies not so much related to the capex cycle.