Larsen & Toubro (LT IN) Well played on all fronts but for margins

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1 INSTITUTIONAL EQUITY RESEARCH Larsen & Toubro (LT IN) Well played on all fronts but for margins INDIA CAPITAL GOODS Quarterly Update Top takeaways from 3QFY19 Recurring PAT (Rs 20.4bn, 36% yoy) was 20%/8% above our/consensus estimates. However, quality of earnings was poor as (1) lumpy profit in reality division (Rs 5.5bn), (2) higher than expected profitability in financial services, (3) higher other income and (4) lower associate losses drove profits while core infrastructure segment profits declined 15% yoy on cost provisions (Rs 4bn). Domestic E&C revenue grew 32% yoy, 5 th consecutive quarter of double digit growth. EBITDA margins expanded by 25bps to 11.2% (vs. our estimate of 11.5%). Operating profitability was driven by robust growth in its Financial and IT services verticals (contributed 40% of EBITDA vs. 32% yoy) and a net positive impact of Rs 1.5bn from gain in real estate which offset provisions in the infra segment. Leading to 27% yoy growth in EBITDA. Ex services order inflows (Rs 341bn) declined 18% yoy due to weak domestic orders (76% of total, 27 yoy) partly supported by growth in overseas orders (+32%). L&T managed its working capital despite pick up in execution. NWC to sales was flat qoq at 19.8%. Conference call takeaways Maintained its FY19 guidance for order inflows (10 12% yoy) as 4Q prospect list remains strong, revenue of 12 15% yoy (likely to achieve the upper band) and margin (exservices) +25bps. Aggregate prospects of Rs 1.6tn for 4QFY19 with Infra accounting for 63%, Power 19%, Hydrocarbon 9%, Metals 6% and Heavy engineering (including defence) is 3%. Reality division has an inventory of ~2700 flats across three residential projects viz. Emerald Isle (phase I & II), Crescent Bay (Mumbai) and Raintree Boulevard (Bangalore). Off these, 1700 flats have been booked but not yet delivered. Outlook and valuation: L&T managed the liquidity crisis in 3Q without compromising on execution. Even as new orders declined yoy but they were still higher than consensus estimates as the surprise came from unreported orders. With a decent pipeline in 4Q, L&T should be able to see through the period of uncertainty around elections. We maintain our Buy rating on L&T as we believe (1) incrementally, the environment for execution has improved and L&T s strong order book (2.7x TTM sales) and controlled working capital allow it headroom to push for execution; and (2) we expect L&T to gain market share as complexity of projects increase over next three years coupled with pickup in ordering from the Middle East could offset the temporary slowdown in domestic orders. We marginally raise our FY20 estimates by 2% to factor in higher cash balance on reversal of its buyback offer. Our estimates bake in the impact flat infrastructure margins over FY18 21 and lower profitability in IT and Financial services in FY20 21 as their performance peaks in FY19. We also do not build in inflows from the E&A divesture and potential benefits from monetization of real estate alongside Hyderabad metro. We tweak our SOTP based target price to Rs 1,520 (Rs 1,530 earlier). We ascribe 23x PE (September 2020) to L&T s core operations vs. 23x (June 2020) earlier. Key risk: Further deterioration in infrastructure segment margins. 28 January 2019 BUY (Maintain) CMP RS 1288 TARGET RS 1520 (+18%) COMPANY DATA O/S SHARES (MN) : 1402 MARKET CAP (RSBN) : 1818 MARKET CAP (USDBN) : WK HI/LO (RS) : 1470 / 1183 LIQUIDITY 3M (USDMN) : 44.0 PAR VALUE (RS) : 2 SHARE HOLDING PATTERN, % Dec 18 Sep 18 Jun 18 FII / NRI : FI / MF : NON PRO : PUBLIC & OTHERS : KEY FINANCIALS Rs bn FY18 FY19E FY20E Net Sales 1, , ,578.1 EBIDTA Net Profit EPS, Rs PER, x EV/EBIDTA, x PBV, x ROE, % Debt/Equity (%) CHANGE IN ESTIMATES Revised Est. % Revision Rs bn FY19E FY20E FY19E FY20E Revenue 1, , % 0% EBITDA % 4% Core PAT % 2% EPS (Rs) % 2% Jonas Bhutta ( ) jbhutta@phillipcapital.in Vikram Rawat ( ) vrawat@phillipcapital.in (Rs mn) Q3FY19 Q3FY18 Change yoy vs. expect. Comments Order book 2,840,490 2,707,270 5% 1% Order inflows 422, ,300 12% 27% Weak domestic orders ( 22%) partly offset by strong overseas inflows (+30%) Sales 357, ,475 24% 8% Led by strong growth across all the segments except power. EBITDA 39,963 31,430 27% 4% Supported by gain in real estate business along with strong profitability in IT and financial EBITDA margin (%) 11.2% 10.9% 26 bps 33 bps services segments offsetting the weak margins in infrastructure. Recurring PAT 20,416 15,037 36% 21% Aided by higher other income and lower share of losses from associates Page 1 PHILLIPCAPITAL INDIA RESEARCH

2 Consolidated results L&T consolidated quarterly results Rs Mn Q3FY19 Q3FY18 Change yoy Order inflows 422, ,300 12% Domestic 307, ,950 22% International 114,540 88,350 30% Order book 2,840,490 2,707,270 5% Domestic 2,249,490 2,039,270 10% International 591, ,000 12% Net Sales 357, ,475 24% Domestic 242, ,375 30% International 114, ,100 14% Gross Profit 102,755 88,512 16% Gross margin (%) 28.8% 30.8% 201 bps Employee costs (46,066) (38,386) 20% Other expenses (16,726) (18,697) 11% EBITDA 39,963 31,430 27% EBITDA margins (%) 11.2% 10.9% 26 bps Depreciation (4,490) (4,545) 1% EBIT 35,474 26,885 32% Interest (5,349) (3,625) 48% Other Income 6,064 2, % PBT 36,189 25,399 42% Tax (12,002) (7,372) 63% Effective tax rate (%) 33% 29% 414 bps PAT pre Minority 24,188 18,027 34% PAT margin (%) 6.8% 6.3% 50 bps Less: Minority Interest (3,207) (1,279) 151% Add: Profits of Associates (565) (1,711) 67% Recurring PAT 20,416 15,037 36% Exceptional (138) 100% Reported PAT 20,416 14,900 37% Recurring EPS (Rs) % Group segment wise order inflows Y/E Mar, Rs mn Q3FY19 Q3FY18 Change yoy Infrastructure* 219, ,970 18% Power ,200 97% Heavy Engineering* 5,530 12,780 57% Defence Engineering* 4,950 na Hydrocarbon 77,740 74,680 4% E&A 16,049 13,744 17% Others* 16,906 29,534 43% Order Inflows ex services 340, ,907 18% Domestic ex services 259, ,573 27% International ex services 80,861 61,334 32% Services 81,540 65,393 25% Domestic Services 47,861 38,377 25% International Services 33,679 27,016 25% Order Inflows total 422, ,300 12% Domestic 307, ,950 22% International 114,540 88,350 30%, * not comparable due to restatement Group segment wise order book Y/E Mar, Rs mn Q3FY19 Q3FY18 Change yoy Infrastructure 2,192,580 1,992,970 10% Power 81, ,160 24% Heavy Engineering 48, ,070 61% Defence Engineering 114,850 na Hydrocarbon 316, ,720 9% E&A 28,500 28,790 1% Others 58, ,560 64% Total Order book 2,840,490 2,707,270 5%, * not comparable due to restatement Page 2 PHILLIPCAPITAL INDIA RESEARCH

3 L&T Consolidated segment revenue Rs Mn Q3FY19 Q3FY18 Change yoy Infrastructure 183, ,238 23% Power 9,083 12,699 28% Heavy Engineering 6,928 3,915 77% Defence Engineering 10,449 7,403 41% Hydrocarbon 37,777 30,899 22% E&A 15,647 12,875 22% IT&TS 37,641 29,150 29% Financial Services 32,589 26,343 24% Development Projects 11,935 10,315 16% Others 16,611 9,616 73% Segment gross revenue 362, ,452 24% Less: Intersegment (5,284) (4,977) 6% Net revenue 357, ,475 24% L&T Consolidated segment EBIT Y/E Mar, Rs mn Q3FY19 Q3FY18 Change yoy Infrastructure 7,656 9,837 22% Power % Heavy Engineering 1, % Defence Engineering % Hydrocarbon 2,699 2,067 31% E&A 2,176 1,755 24% IT&TS 7,616 5,584 36% Financial Services 7,758 3, % Development Projects % Others 7,285 2, % Segment EBIT 37,272 26,873 39% Less: Intersegment margins % Add: Un allocable income, net (1,851) (84) 2106% EBIT 35,474 26,885 32% EBIT margin (%) Infrastructure 4.2% 6.6% 242 bps Power 1.7% 1.6% 10 bps Heavy Engineering 15.1% 20.2% 512 bps Defence Engineering 5.3% 2.8% 248 bps Hydrocarbon 7.1% 6.7% 45 bps E&A 13.9% 13.6% 28 bps IT&TS 20.2% 19.2% 108 bps Financial Services 23.8% 14.1% 967 bps Development Projects 2.7% 6.5% 379 bps Others 43.9% 21.1% 2274 bps Segment EBIT 10.3% 9.2% 110 bps Page 3 PHILLIPCAPITAL INDIA RESEARCH

4 Standalone Results L&T Standalone quarterly results Rs Mn Q3FY19 Q3FY18 Change yoy Net Sales 223, ,180 26% Gross Profit 43,083 37,554 15% Gross margin (%) 19.3% 21.2% 191 bps Employee costs (15,078) (14,297) 5% Other expenses (6,602) (6,531) 1% EBITDA 21,403 16,725 28% EBITDA margins (%) 9.6% 9.4% 14 bps Depreciation (2,683) (2,650) 1% EBIT 18,720 14,075 33% Interest (4,886) (3,305) 48% Other Income 8,870 4,463 99% PBT 22,704 15,233 49% Tax (6,356) (3,582) 77% Effective tax rate (%) 28.0% 23.5% 448 bps Recurring PAT 16,348 11,652 40% Exceptional % Reported PAT 16,348 12,220 34% L&T Standalone segment revenue Rs Mn Q3FY19 Q3FY18 Change yoy Infrastructure 172, ,006 23% Power 9,083 12,699 28% Heavy Engineering 6,928 3,766 84% Defence Engineering 10,129 7,464 36% E&A 12,890 10,320 25% Others 13,144 4, % Segment gross revenue 225, ,641 25% Less: Intersegment (1,663) (2,462) 32% Net revenue 223, ,180 26% L&T Standalone segment EBIT Y/E Mar, Rs mn Q3FY19 Q3FY18 Change yoy Infrastructure 7,315 10,262 29% Power % Heavy Engineering 1, % Defence Engineering % E&A 2,177 1,609 35% Others 7, % Segment EBIT 18,791 14,527 29% Less: Intersegment margins (13) (36) 65% Add: Un allocable income, net (58) (416) 86% EBIT 18,720 14,075 33% EBIT margin (%) Infrastructure 4.2% 7.3% 305 bps Power 1.7% 1.4% 26 bps Heavy Engineering 15.1% 23.4% 838 bps Defence Engineering 8.2% 8.8% 67 bps E&A 16.9% 15.6% 130 bps Others 55.3% 21.2% 3409 bps Segment EBIT 8.3% 8.1% 26 bps Page 4 PHILLIPCAPITAL INDIA RESEARCH

5 Financials Income Statement Y/E Mar, Rs bn FY18 FY19e FY20e FY21e Net sales 1, , , ,800.7 Growth, % Total income 1, , , ,800.7 Raw material expenses , ,249.8 Employee expenses Other Operating expenses EBITDA (Core) Growth, % Margin, % Depreciation EBIT Growth, % Margin, % Interest paid Other Non Operating Income Pre tax profit Tax provided Profit after tax Others (Minorities, Associates) Net Profit Growth, % Net Profit (adjusted) Unadj. shares (m) 1,401 1,404 1,407 1,409 Wtd avg shares (m) 1,401 1,404 1,407 1,409 Balance Sheet Y/E Mar, Rs bn FY18 FY19e FY20e FY21e Cash & bank Debtors Inventory Loans & advances , ,174.8 Other current assets Total current assets 1, , , ,869.5 Investments Gross fixed assets Less: Depreciation Add: Capital WIP Net fixed assets Total assets 2, , , ,290.3 Current liabilities ,019.3 Provisions Total current liabilities ,076.7 Non current liabilities 1, , , ,360.8 Total liabilities 1, , , ,437.5 Paid up capital Reserves & surplus Shareholders equity Total equity & liabilities 2, , , ,290.3 Cash Flow Y/E Mar, Rs bn FY18 FY19e FY20e FY21e Pre tax profit Depreciation Chg in working capital Total tax paid Cash flow from operating activities Capital expenditure Chg in investments Cash flow from investing activities Free cash flow Equity raised/(repaid) Debt raised/(repaid) Dividend (incl. tax) Other financing activities Cash flow from financing activities Net chg in cash Valuation Ratios FY18 FY19e FY20e FY21e Per Share data EPS (INR) Growth, % Book NAV/share (INR) FDEPS (INR) CEPS (INR) CFPS (INR) (84.9) (13.5) (11.5) (11.7) DPS (INR) Return ratios Return on assets (%) Return on equity (%) Return on capital employed (%) Turnover ratios Asset turnover (x) Sales/Total assets (x) Sales/Net FA (x) Working capital/sales (x) Working capital days Liquidity ratios Current ratio (x) Quick ratio (x) Interest cover (x) Dividend cover (x) Total debt/equity (%) Net debt/equity (%) Valuation PER (x) PEG (x) y o y growth Price/Book (x) Yield (%) EV/Net sales (x) EV/EBITDA (x) Estimates Page 5 PHILLIPCAPITAL INDIA RESEARCH

6 Stock Price, Price Target and Rating History N (TP 1280) N (TP 1750) N (TP 1220) N (TP 1390) N (TP 1390) B (TP 1530) N (TP 1415) 900 N (TP N 1420) (TP N 1420) (TP 1400) N (TP 1565) N (TP 1400) 700 N (TP 1220) 500 J 16 F 16 A 16 N (TP 1420) J 16 A 16 O 16 N 16 J 17 F 17 M 17M 17 J 17 A 17 S 17 N 17 D 17 N (TP 1390) M 18M 18 J 18 N (TP 1415) S 18 O 18 D 18 Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition BUY >= +15% Target price is equal to or more than 15% of current market price NEUTRAL 15% > to < +15% Target price is less than +15% but more than 15% SELL <= 15% Target price is less than or equal to 15%. Page 6 PHILLIPCAPITAL INDIA RESEARCH

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