L&T margin: Hope versus reality

For investors in Larsen and Toubro Ltd’s (L&T) stock, weak margin has been a pet peeve in recent times. Unfortunately, FY23 was no different. The infrastructure bellwether’s core engineering and construction (E&C) Ebitda margin for FY23 stood at 8.6%, dipping for the second consecutive year. This also falls short of the firm’s earlier guidance of 8.8-9%. What’s more, the company does not expect a meaningful improvement in the scenario. Its management expects core segment margin to be at 9-9.1%.

Investors are having a hard time digesting this, which is evident from the 5% fall in L&T’s share price on Thursday in reaction to its latest results and management commentary.

In its earnings call, the management said that high input costs hurt margins, but a large portion of E&C projects with high costs are already being executed. So, while core margins have scope to improve in FY24, it is only likely in the second half of the year. But the management also acknowledged that competitive intensity is high and, hence, achieving core margin seen in pre-covid times would be challenging, at least, for the near term. According to an Ambit Capital report, L&T continues to face increasing competition from Tata Projects, Megha Engineering and Afcons, resulting in lower growth and margin pressure.

Nonetheless, the L&T management said the worst on margin compression is behind it. Analysts are cautious. “Revival in core margin will be a gradual process, at best, and reaching close to pre-covid core margin is still four-six quarters away,” said Amit Anwani, analyst, Prabhudas Lilladher. “Plus, there is an event-based risk with general elections ahead, so timely execution of government projects is crucial for margin recovery,” he said. L&T has meaningful exposure to government projects, and elections scheduled across several states this year may have some impact. “In all, high competition in bidding for infrastructure projects makes us believe that below 10% margin is a new-normal, for now,” he added.

To be sure, L&T’s revenue growth guidance for FY24 seems discouraging as well, despite a robust order book of 4 trillion at March-end. For FY23, core E&C order inflow grew 19% year-on-year to 1.7 trillion. The management highlighted that order prospect pipeline for FY24 is healthy at 9.7 trillion. For FY24, L&T has guided 10-12% growth in order inflows. “Management has guided for 12-15% (FY24) revenue growth, despite book-to-bill of ~3.2x, which seems slightly moderate to us,” Emkay Global Financial Services said.

Investors have, however, noted the robust order inflows. In the last one year, L&T’s shares have sharply outperformed over the benchmark Nifty 50 index, rallying by almost 43%. What is more, L&T has seen improvement in its net working capital (NWC) at 16.1% of revenue as on March. The management expects it to sustain at 16-18% in FY24. Going ahead, a steep upside in the stock may be capped given the challenges, especially on margin revival. Besides, a niggling concern for L&T investors remains the exposure to non-core assets such as Hyderabad Metro rail project and Nabha Power Project Ltd.

Hiving-off these assets is critical for its capital allocation strategy and return on equity outlook. There has not been much progress on this front.

“While the street relishes order inflow growth, we believe L&T struggles with a difficult choice of maintaining growth, margins and NWC/capex at the same time. Even as valuations suggest that the street expects it to deliver on all parameters, a miss on any one will lead to weak cash generation,” the Ambit report said.

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