Friday, May 20 2022

Key Point: We believe L&T’s order flow trajectory is expected to increase to 15% CAGR in FY21-24E from 10% over the past 10 years. Railways, including metro projects, Power T&D related to renewable energy generation, roads, PLIs and data centers are all expected to contribute to higher growth ahead. Earnings are starting to reflect the upside, but valuations are below mid-cycle multiples. We believe that order flow and announcements of strategic plans over the next six months should correct this.

Key Point: We believe L&T’s order flow trajectory is expected to increase to 15% CAGR in FY21-24E from 10% over the past 10 years. Railways, including metro projects, Power T&D related to renewable energy generation, roads, PLIs and data centers are all expected to contribute to higher growth ahead. Earnings are starting to reflect the upside, but valuations are below mid-cycle multiples. We believe that order flow and announcements of strategic plans over the next six months should correct this.

” To buy “. Order inflow of Rs 308 billion reported in Q3 to date indicates at least 8% year-on-year growth for the quarter: L&T reported 28% orders in Hydrocarbons, 24% in Water and irrigation and 12% in Power T&D in Q3 to Date. Our estimates take into account announcements of 316 billion rupees in the 3rd quarter, with two weeks to go. The overall order flow, including unannounced, is expected to be Rs 791 billion, implying an 18% year-on-year growth at 9MFY22.

This keeps L&T comfortably positioned to meet FY22E order flow forecasts of 13-17% year-over-year growth. The Rs 10 billion+ order from Prestige Estates for the construction of a residential township in Bengaluru is a renowned real estate project. Jefferies Property analyst Abhinav Sinha remains positive on the housing cycle, and we believe this sector could offer a significant upside in order flow. Buildings and factories accounted for 28% of announced order flow at the peak and are currently below 12%.

Strong infrastructure capex spending pull – rail and road hub spending increased 51% year-over-year: 74% of L&T’s backlog is driven by infrastructure. Railways (including subways), T&D Energy, Water and Roads have typically accounted for 55-65% of this spending in the past. Reports from the Department of Housing and Urban Affairs indicate a CAGR of 23% in operational metro kilometers in FY21-25E compared to 20% in FY14-21. Power T&D, which has dipped to low single digit growth for the past three to four years, is expected to accelerate into teens in fiscal 21-24E. The 2.4x TQ increase in Power Grid’s bid pipeline goes in the same direction.

NHAI forecasts 23% annual growth in awards in FY22E to $30 billion. NHAI’s -$22bn monetization plans for FY23E-25E, a 10% jump from previous fund issuances, provide reassurance that strong double-digit growth will continue over the medium term. Data centers, PLI and steel expected to drive private sector investment: Private sector capex is the sweetener for L&T on margins and working capital, and accounts for 15% of backlog current against 30% and more at the top. Our estimate of order flow for FY22E is 15% YoY and the current pick-up in investment momentum should reflect continued mid-teen growth in FY23E-25E .

Valuations indicate revaluation in historical context: L&T’s average EV/EBITDA multiple was 11.3x in FY15-19 and 13.4x in FY08-12, when the order flow CAGR was 6% and 13%, respectively. For FY22E-24E, we expect a CAGR of 15%, with an EBITDA CAGR of 22%. The FY20-21 base has a strong impact on Covid as E&C companies are financially heavy in Q4 and nationwide lockdown started from late March 2020.

We believe that L&T should at least be reassessed compared to FY15-19, as on most financial metrics, including ROE, there should be improvement. The core business is currently trading at 8.4x EV/EBITDA FY24E excluding subsidiary valuations. Hold long with a PT of Rs 2,845 (consol PB of 4.0x and 18.3 EV/EBITDA FY24E). Risks: 1) Management not following a prudent capital allocation; 2) government infrastructure spending is low.

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