Despite scaledown, L&T order inflow guidance healthy: Kotak

Q: Margins of Larsen and Toubro (L&T) certainly were good and so were revenues and profit if you adjust it for hydrocarbons, what is your overall view on the stock first?

A: After having swung on both sides of fair value it is broadly the fair value today and to that extent should basically in that sense be priced at something like 14.5-15 times FY15, something like 12.5 times FY16 which essentially does not give you either a bullish or a bearish conviction right now in that sense, compounded that with quarterly surprise which has come in on the margins. We would want to see whether this can sustain over a period of time in some sense or want to sort of take up more stronger directional view.

Q: Will the reduction in the order inflow guidance worry you or do you think that given that it is an election year and there is some talk of them losing some of the EPC projects like Karanpura etc. that is not totally out of whack?

A: I would tend to perceive that order inflow guidance actually broadly remains the same, to that extent there were percentage growth numbers which is about 15-20 percentage of share. I think they are still maintaining the same range. It is essentially that there is always an uncertainty around that number, because that is not a number that L&T can actually control itself. It has better control on its own execution and margins. So I am not actually taking it as there is a reduction in order inflow margin guidance definitely.

Q: What is your price target now?

A: Our price target is Rs 1,000 now which is why I said it is broadly at fair value in our judgement.

Q: Isn't the margins impressing you? Like you said they do not have control over their order book, but on what they have control they have done well in margins.

A: Yes, margin performance in entire FY14 has been extremely impressive. We particularly look at gross margin, which is also what you can refer to as contribution margin and that margin has been expanding as a big surprise to us, because our understanding was that contribution margin could actually trend lower on the basis of mix, inflation, slowdown and competition, but at least so far in FY14 that has not happened. We would actually be a little doubtful whether this kind of contribution margin which is at 4-5 years high can actually sustain going forward because of all these risks that I mentioned, but at this point of time, yes they have definitely surprised big time on gross margins.

Q: So since you do believe that the stock is currently at fair value what are the triggers that could actually take the stock well above this level now?

A: There will be two triggers which I would essentially be watching out for, one is the margins. As we discussed if the margin sustains somewhere nearby to current levels then obviously stock would have that much more upside to it. Second event development is some sort of value realisation that could happen in infrastructure development portfolio. We are a little cautious of that, but that is a transaction which is under discussion and can come in as a positive event at some point of time.