Guarded commentary already discounted in L&T, buyback could re-rate stock

After a rock-solid earnings performance by Larsen & Toubro (L&T), investors are like a cat on hot bricks. The nervousness in the market is largely because of the guarded commentary from the management.

Most brokerage firms have baked in weak profitability for the infrastructure player along with a gradual margin recovery. Additionally, a rating downgrade on L&T shares by Kotak Institutional Equities to ‘add’ from ‘buy’ also made investors somewhat jittery.

The stock movement since its Q2 result has been a bit lacklustre with the scrip oscillating between losses and gains. However, a section of the market buyback is yet to be factored in, said an analyst at a foreign brokerage firm. He added that there could be another leg of re-rating in case of a buyback announcement.

The company, in a post-earnings conference call, had said that at the start of the next financial year, return on equity would improve to 18 percent from 11 percent thanks to metro projects in various cities, divestments and consistent margins and growth. It added that buyback is definitely being talked about in the group.

A buyback would reduce the assets on its balance sheet which implies that return on assets would increase because assets are reduced and return on equity would also improve because there is less outstanding equity.

On the profitability front, the management said margins in the first half of FY23 are lower than in the first half of FY22. But it believes softening of commodity prices and revenue uptick in the second half of FY23 will help improve margins on an annualised basis. However, supply chain issues among other challenges can have an impact on margins but it will still be near the company’s provided guidance, it added.

L&T has remained cautious for its EBITDA (earnings before interest, taxes, depreciation and amortisation) margin guidance of around 9.5 percent for FY23, owing to supply chain issues and higher input costs.

Given healthy order prospects and order book, the management has maintained its revenue and order inflow guidance of 12-15 percent.

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Even as revenue and order inflow guidance has been retained for FY23, Nomura said it appears conservative against present trends. “L&T reported strong order inflows of Rs 519 billion (+107% y-y), implying a single-digit growth rate in 2HFY23F (to 15 percent). We view this guidance as conservative,” said Priyankar Biswas of Nomura in a note to clients.

“The company’s cautious outlook on margin despite several tailwinds was a dampener and this too may have impacted investor sentiment,” said Khadija Mantri, assistant vice-president, research, Sharekhan by BNP Paribas.

The management has given a cautious margin outlook for FY23 but she added that it also alluded to the fact that if the proportion of private orders increases in the order book, it could see margin improvement as these orders are on a nomination basis and carry higher margins. Further, new orders have been taken at better pricing and this would also help improve margins in the medium to long term.

“Any positive surprise on the margin front in H2FY23 could give fillip to the stock,” she said, adding that a robust outlook in terms of revenue, order intake and monetisation of its non-core assets could also support the stock.

L&T shares have gained close to 10 percent in the past month on the back of decent performance by its IT and ITeS subsidiaries and expectations of a good performance in the September quarter. Therefore, an uninspiring stock movement is an indication that a good set of quarterly numbers has prompted investors to take some money off the table, analysts believe.

“The stock has run up quite a bit recently, and is hovering around its lifetime high and has also outperformed the market. Plus, with the earnings now behind, there is some profit-taking now,” said Parikshit D Kandpal of HDFC Securities.

At 11.15 am, the scrip was trading at Rs 2,006.55, down 0.9 percent, on the BSE. It had hit its 52-week high of Rs 2,078.20.

The company has been able sustain its margins in a challenging environment with inflationary pressure and supply chain issues. “The lower end of the margin guidance itself is conservative, which provides comfort that L&T can achieve its guidance. So a cautious margin outlook is not that big a worry and has already been factored into the current stock price,” Kandpal explained.

He feels the outlook for L&T seems more promising from here on due to a couple of positives like the company reducing losses in its Hyderabad Metro Project, the IDPL divestment and a likely buyback on the cards.

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