BackL&T results: key issues for the firm and the economy
The firm's Q1 results are crucialthey will set the tone for expectations on capex cycle, revival of investment demand over the next 12-18 months
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Larsen & Toubro Ltd (L&T), the bellwether of the country’s infrastructure sector, is set to declare its first-quarter results on Friday. The firm’s stock performance indicates that the investor mood is quite subdued. With a 24% weightage in the BSE Capital Goods index, it has underperformed the same since January.
The company’s June quarter results are crucial in that they will set the tone for expectations on the capex cycle and the revival of investment demand over the next 12-18 months. The key issues that L&T’s results would address are:
—Order inflows and economic outlook
A robust 39% year-on-year jump in order inflows along with its huge order book of around ₹ 2.32 trillion were the bright spots in the otherwise gloomy March quarter. But expectations are not so high for the June quarter. Analysts’ estimates are that domestic orders would be subdued and perhaps a tad lower than the average of four quarters in fiscal 2015.
Indeed, there’s optimism in the economy to the extent that the worst is over. But then, with little capex activity in the industrial sector and the increased budgetary outlay for infrastructure during the year yet to fructify into orders for companies, a huge bump up in order inflow would be a positive surprise for the Street. Meanwhile, a Motilal Oswal Financial Services Ltd report says that overseas wins have been muted, particularly impacted by the sharp decline in crude prices, and that three-month moving average order awards in the Middle East are down 50% year on year.
That said, L&T’s order inflow profile will indicate the level of activity across economic sectors. Order pricing (expected to be weak) is a crucial peg for future earnings estimates.
—Project execution and revenue ramp-up
L&T’s revenue ramp-up took a beating in fiscal year 2015. Weak project execution and poor advances from clients mirrored the desperate state of financial health of companies during the March quarter.
Even a marginal improvement in this respect would be cheered by the Street, although expectations are that L&T’s consolidated revenue growth for the June quarter would be within 10% year-on-year.
One must also look out for the sectoral contribution to revenue. In the previous quarter, the engineering division, which accounts for 80% of revenue, hardly grew, with much of the consolidated revenue expansion coming from non-core sectors such as information technology and financial services. Further, revenue from last fiscal year’s orders would accrue with a lag, as much of these orders came in during the March quarter. Management comments, if any, on the Middle Eastern economies are also important to determine future traction in international order flow and revenue.
—Working capital constraints
One would think that L&T’s gigantic size would give it an edge in booking orders and pricing power. But the firm’s working capital needs as a percentage to sales have steadily risen from 10% in fiscal 2011 to 32% in 2015. Analysts reckon this would be high for a few more quarters, given tight liquidity conditions, stiff payment terms on projects and stretched balance sheets of the firm’s clients.
Any improvement therefore would be a harbinger of improving credit profile in the economy. Importantly, this would impact net profit even if the operating performance is robust.
—Sorting out its subsidiaries
The consensus on the Street is that the worst is behind its loss-making subsidiaries, be it ship-building, hydrocarbons or nuclear forging. Some brokerage reports suggest that further provisioning towards huge subsidiary losses is unlikely during the June quarter.
Meanwhile, the status of monetization of non-core assets and initial public offering of its infotech subsidiary are key to consolidated earnings estimates for the near and medium term.
Of course, these are major issues that investors are hopeful of being addressed in the June quarter results. In addition, investor sentiment would be influenced by operating margin—Bloomberg’s consensus estimate is 11.9%, about 100 basis points lower than that turned out in the year-ago period. Operating profit to a large extent would mirror revenue growth, given L&T’s strength in cost control.
And one cannot ignore the management commentary which would throw light on the company’s prospects but would be crucial to determining ground reality changes in economic activity.
The investor mood is dull as seen in the stock price that closed a tad lower on Thursday in spite of a rise in the broad benchmark indices. Yet, the prevailing price of ₹ 1,776.2 discounts the one-year forward estimated earnings by about 28 times, a fair valuation given the uncertainties both at the macro and company level.
The writer does not have positions in the companies discussed here.
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