See L&T margins at 9-10%; buy on declines: Kotak Sec

The country's largest engineering and construction company's third quarter (October-December) net profit grew 10.6 percent year-on-year to Rs 1,241 crore compared to a year ago period. After considering the exceptional gain on dilution of part stake in a subsidiary company (hydrocarbon), (adjusted) profit after tax soared over 22 percent during the quarter.

L&T has lowered its full year guidance for order inflow saying it may end FY14 with 15 percent growth in order inflow than 20 percent earlier

Also read: Cautious on L&T, Yes Bank; upbeat on Dabur, IT: HDFC Sec 

Below is verbatim transcript of his interview with CNBC-TV18's Anuj Singhal and Ekta Batra

Anuj: Do you think the margin performance that the company had delivered will lead to a bit of a rerating on the stock as we have seen in today’s trade also about 3 percent or you will not like to read too much to that?

A: Basically the margin performance is more of kind of a relief so far as the investor community is concerned because there were concerns that the share of exports has been rising. The order book is getting skewed towards infrastructure side and the kinds of margins that have come to some extent have eased investor concerns so far as the margin outlook going forward.

However, if you look at the trend of margins in the engineering, procurement and construction (EPC) business, it is typically in the range of 9-12 percent that kind of a range. So these margins are on the higher side as compared to the historical trend. We would be looking more at 9-10 percent margins on a sustainable basis.

Ekta: Can you just give us a sense on what led to the margin performance if you look at the profit and loss (P&L) and if you went through it, was it the exclusion of the hydrocarbon business also to a certain extent that helped in the performance of the business?

A: Yes, to some extent if we look at the EBITDA margins that were reported in Q1 and Q2 in the hydrocarbon business those were a bit inferior to the margins at the parent level. So that could be one of the factors. The other factor was the infrastructure business, which constitutes around 60-65 percent of the revenues and that grew at very robust way and apart from that there were positive tailwinds coming from sell of properties in the Powai development and also the ship building, which is basically housed under others category, in that segment there were only minor losses, most of the losses were to some extent taken in Q2 itself. So that in a way led to a margin beat in this quarter.

Ekta: What is the sustainability of the margins you think and do you think that you would be revising your EPS or your FY15 estimates just based on any sort of improvement or sustainability of improvement in margins going forward?

A: We were looking at a downward bias so far as the margins were concerned in FY15 but after Q3 numbers we would temper our outlooks so far as the downside in the margins are concerned and we would be comfortable at margins remaining stable in FY15 over FY14. So we are looking at a stable margin outlook. Though if such margins trend continues then there could be some upward bias to our FY15 margin but largely we are quite comforting so far as the future margins are concerned after the numbers that they have reported.

Anuj: What about the cut in order book guidance, the market is not reacting to that and sort of ignored that, why is that? Is it no longer as important as it used to be - what is your own call in terms of the order book for L&T going forward in terms of new orders? Do you think they will be able to meet the revised guidance?

A: For meeting the revised guidance, they need to do around similar kind of orders that they won in Q3. So around Rs 21,000-23,000 crore they need to win in Q4. So, typically Q4 is on the higher side but since we are entering into election timeframe and to that extent there could be some impact on decision making. So there is possibility of some orders getting deferred into the next quarter.

However, an overall basis, the company has a canvas of around 1 lakh crore of orders that they are looking at to get awarded. So basically it is a matter of timeframe. Some orders could get deferred. So that is the risk that we are seeing.

Ekta: Just wanted to focus on the working capital bit of L&T because that according to the bears on the street is quite a concern. The working capital has been increasing every quarter, would that be a problem? How do you think that the debt situation on the short-term working capital situation would pan out for L&T going forward?

A: That is a negative takeaway that we took from the numbers. So that is why we look at the numbers as a mixed bag while the margins surprised us on the positive side. But clearly on the balance sheet side, we see a bit of deterioration.

Working capital to sales has continued to climb up including in Q3. So as a result cash flows from operations have been quite marginal. So although we want to see revenue growth margins coming at expected levels, but the cash flow generation is also equally important because in the future they also need to infuse some cash for their development projects.

Anuj: What is your call on the stock and would you be changing your numbers after what happened yesterday?

A: No, we have largely maintained our numbers and our call on the stock has been that we view the stock at these levels at more or less fairly valued and our target price is Rs 1,079. So we are recommending investors to buy the stock on any declines from these levels.

Ekta: Rs 1,079 target price is very close to where this stock is currently trading at, what would be the upside potential to your target price if you have one?

A: We are recommending investors to buy a stock on decline. So if the stock comes to sub Rs 1,000 levels at around Rs 980-990 that could be a decent upside for our target price of Rs 1,079. So those could be our levels wherein we could turn buyers in the stock.