See L&T improving margins from current levels: Anand Rathi

In an interview to CNBC-TV18, Amol Rao, research analyst, Anand Rathi gives his views on engineering and construction company, Larsen and Toubro (L&T) disappointing Q3 numbers. The company's Profit after tax (PAT_ grew by 12.9 percent year-on-year, in-line with analysts' expectations while revenues rose by 10.2 percent, tad lower than forecasted.

However, Rao is optimistic on the company's performance. "The fact that most of the company's contracts in the engineering and construction (E&C) space are on the variable pricing mechanism, does add a level of comfort to our estimates. So, we are cautiously optimistic that the company would improve margins from current levels," he adds.

Rao says the Q3 numbers were in-line with their expectations because they had anticipated an intensely competitive opearting environment. "However, it was reassuring to hear the company say that margins have bottomed out at current levels and going forward, they should be able to claw back somewhere from the range of 25-50 bps in the coming quarters," he says.

Below is the edited transcript of Rao's inteview to CNBC-TV18.

Q: Any upgrades on earnings at all? Or have you left it untouched after seeing yesterday’s results?

A: We believe that although the results were fairly in-line with our expectations, there still remains to be some amount of clarification that is sought on the macroeconomic scenario.

Hence, we have left our recommendation untouched. However, we are optimistic about the company’s prospects looking at the body language and the slow yet steady change in the underlying of the environmental scenario at present.

Q: What did you make of the margin compression in the current quarter? Does it worry you that it could lead eventually to some kind of an earnings miss?

A: The margins were fairly in-line with our expectations because we had anticipated an intensely competitive operating environment. However, it was reassuring to hear the company say that margins have bottomed out at current levels and going forward, they should be able to claw back somewhere from the range of 25-50 bps in the coming quarters.

The fact that most of the company’s contracts in the engineering and construction (E&C) space are on the variable pricing mechanism does add a level of comfort to our estimates. So, we are cautiously optimistic that the company would improve margins from current levels.

Q: The order booking was ahead of expectations but they did not book the cancellations from GMR and GVK. Do you expect that to take away from the overall order picture in Q4?

A: There would be a sentimental impact of these orders, but in the overall scheme of things, even if you take a worst case scenario, Rs 4,000-5,000 crore on a total order book base of around Rs 1,62,000 crore hardly adds up to 3-3.5 percent. So, while it would be sentimentally negative, the underlying positive could be that the company will not have to dedicate any assets or employ any capital to execute these projects which are long pending and anyway in the slow moving order book of the company.

Q: What do you expect to hear from the rest of the sector? As more results kick-in from infrastructure, do you expect to see a lot more pain than what L&T reported yesterday?

A: More than the pain in the order booking, I think it would be very crucial to hear what the managements have to say about the scenario that is panning out on the regulatory front or on other issues like capex by various industries It is also evry important to know  if they are experiencing any problems with their funding requirements.

So, all in all, the order booking pain is very well known. What is important to hear from the rest of the sector is how bad it is going to get before it gets better. Early indications are that things are bottoming out and we could be on the path to a very slow yet very steady recovery.

Q: What kind of valuations do you have in mind for L&T now? What is the target price that you have set for it?

A: At current levels, we believe that L&T is fairly valued around Rs 1,665, which is our target price. Any news on items like sale stake in assets like the Dhamra port or any road construction projects, which they managed to sell off or capital raising in Infrastructure Development Projects (IDPL) would act as triggers for the stock. We would be very closely monitoring the macroeconomic scenario. So, we are quite open to upgrading our target price in L&T given any improvement in the near-term scenario.