Bumpy road ahead for L&T as order flows, project execution face challenges

As working capital requirements also rise, analysts estimate earnings to dip in FY21

Larsen & Toubro’s (L&T’s) March quarter (Q4) performance has encouraged analysts to maintain a positive medium-term outlook and ‘buy’ rating on the stock. This was driven by the 5 per cent increase in new orders, along with the commentary on the firm’s preparedness to manage disruption.

 However, it is facing near-term challenges on order inflow, project execution, and increased working capital requirements. This will likely weigh on investor sentiment.
 

L&T’s Q4 revenue growth of 2 per cent was a boost, given the significant decline of 17-20 per cent reported by ABB and Siemens, with order flows also improving.

However, the consolidated order book of above Rs 3 trillion (adjusting for slow-moving orders) grew just 4 per cent, which may not have pleased analysts. Those at Credit Suisse say that an only 4 per cent growth in backlog may imply flattish revenues ahead, even without the Covid impact.

These concerns may remain for FY21. While fresh orders in West Asia and associated regions may slow down because of low oil prices, the lockdown-led disruption will also hinder domestic private capex.

L&T’s management has refrained from giving guidance for FY21, due to uncertainties, even as it is banking on new orders in heavy civil, water, and power TD from states and the Centre, backed by funding from multilateral agencies.

In fact, MD and CEO S N Subrahmanyan said he does not expect significant orders from the private sector in the next 12 months. Against this backdrop, and given that the state and central governments are also facing funding issues, the medium-term outlook for order inflows is weak.

Execution challenges persist too. The commentary suggests Q1FY21 will witness slow execution, given that the current labour force is at 40 per cent of its normal level, say analysts at Emkay Research.

Labour issues may impact 60-70 per cent execution in Q1 and 30-40 per cent in Q2, say analysts. Any delay in projects will lead to cost over-run.

With just 40 per cent of the required labour available, muted flow of new orders, and payment terms continuing to deteriorate, FY21 will be challenging, says HSBC. L&T is in discussions with vendors and customers to optimise the cost over-run due to the lockdown, say analysts.

 

 

Consequently, working capital challenges have emerged. Net working capital was a key concern in Q4, and has risen to 23.7 per cent of sales (YoY increase of 570 bps) — the highest since December 2015 — says Emkay.

Executives said on Friday that the higher ratio was because of support extended to vendors. In addition, “…terms of trade with all our contracts are increasingly become interest-linked when it comes to customer advances. In earlier days, customer advances used to be interest-free; I guess the liquidity squeeze is making people count their pennies. Some of those interest rates are higher than what L&T borrows (at). Therefore, L&T takes contracts without customer advance in case the rate is unreasonable,” said Shankar Raman, whole-time director and CFO.

In a June 8 IIFL note, analysts Renu Baid and Riya Mehta wrote: “Management expects non-availability of funds to give rise to back-ended payment conditions on new orders, incremental retention, or higher deposits. Net working capital requirements for EPC (engineering, procurement and construction) projects have increased in the years and will likely remain at elevated levels of 20 per cent plus sales.”

While the management — in a call with analysts on Saturday — said it was confident there would be no further deterioration in working capital ratios, analysts nevertheless expect some pressure.

L&T’s strong balance sheet, along with Rs 14,000 crore in proceeds from sale of its automation division to Schneider — places it on better ground vis-a-vis smaller peers. It is therefore likely to gain in terms of ability to bid and win new orders.

Further, its services businesses (IT, finance) will support consolidated performance.

Thus, analysts such as Umesh Raut of YES Securities, feel L&T will face near-term headwinds on new orders and execution, but long-term outlook remains strong.