L&T: Earnings beginning to reflect uptick; maintain ‘buy’

Key takeaway: We believe L&T’s order flow trajectory should move to 15% CAGR in FY21-24E vs 10% in the past 10 years. Railways, including metro projects, Power T&D linked to renewable energy generation, roads, PLI and data centre should all contribute to higher growth ahead. Earnings are beginning to reflect the uptick, but valuations are below mid-cycle multiples. We believe order flow and strategic plan announcements in the next six months should correct this.

‘Buy’.Rs 308 billion order flow announced in 3Q to date points to at least 8% YoY growth for the quarter: L&T has announced 28% orders in hydrocarbon, 24% in water and irrigation and 12% in Power T&D in 3Q to date. Our estimates factor in Rs 316-billion announcements in 3Q, with another two weeks to go. Overall order flow, including unannounced, should be Rs 791 billion, implying 18% YoY growth in 9MFY22.

This keeps L&T comfortably placed to meet FY22E order flow guidance of 13-17% YoY growth.Rs 10 billion+ order from Prestige Estates for construction of a residential township in Bengaluru is a marquee real estate project. Jefferies Property analyst Abhinav Sinha remains positive on the housing cycle, and we believe this sector could offer material upside on order flow. Buildings and factories was 28% of announced order flows at the peak and is currently less than 12%.

Infra capex traction strong — railways + road centre spend up 51% YoY YTD: 74% of L&T’s order book is driven by infrastructure. Railways (including metros), Power T&D, water and roads have typically accounted for 55-65% of this in the past. Ministry of Housing and Urban Affairs reports point to a 23% CAGR in operational metro km in FY21-25E vs 20% in FY14-21. Power T&D, which has dropped to single-digit growth in the past three-four years, should accelerate to high teens in FY21-24E. 2.4x QoQ rise in Power Grid’s bid pipeline points to the same.

NHAI plans 23% YoY growth in awards in FY22E at $30 billion. NHAI’s $-22 billion monetisation plans in FY23E-25E,  which is a 10x jump from past fund issuances, gives comfort on this strong double-digit growth continuing in the medium term.Data centres, PLI, steel should drive private sector capex: Private sector capex is the sweetener for L&T on margins and working capital, and is 15% of current order book vs 30%+ at the peak. Our FY22E order flow estimate is 15% YoY and the current investment momentum uptick should reflect in mid-teens growth continuing in FY23E-25E.

Valuations point to re-rating in historical context: L&T’s average EV/EBITDA multiple was 11.3x in FY15-19 and 13.4x in FY08-12, when order flow CAGR was 6% and 13%, respectively. In FY22E-24E, we anticipate 15% CAGR, with 22% EBITDA CAGR. FY20-21 base has a sharp Covid impact as E&C companies are 4Q heavy in financials and the national lockdown started from end March 2020.

We believe L&T should re-rate vs FY15-19 at least, since across most financial parameters, including ROE, there should be an improvement. Core business is currently trading at 8.4x EV/ EBITDA FY24E ex-subsidiary valuations. Maintain ‘buy’ with a PT of Rs 2,845 (consol PB of 4.0x and 18.3 EV/EBITDA FY24E). Risks: 1) Management not following prudent capital allocation; 2) government infra spend being weak.