Guidance revision, margin show help L&T Tech outperform peers in Q1

Investors advised to await a correction and hold the stock for long term to benefit from the demand uptick in the niche engineering, research and development space

The L&T Technology Services (LTTS) stock has hit the upper circuit (20 per cent gain) on Thursday before retreating and closing with an uptick of over 18 per cent. The all-time high levels for the stock came after the company reported a strong June quarter performance and hiked its revenue growth guidance for FY22. Today’s rally extends the stock’s gain over the last year to over 130 per cent. 

Other companies in the parent Larsen and Toubro’s (L&T) software portfolio Mindtree and L&T Infotech (LTI) too have seen strong gains rising between 9-12 per cent over the last couple of trading sessions.

The three information technology subsidiaries of L&T have over the last two years nearly tripled (2.8 times) in value. At just under Rs 1.6 trillion, they are 70 per cent of parent L&T’s market capitalisation. Just two years earlier, the numbers stood at 25 per cent.

Sum-of-parts valuations of L&T pegs the IT subsidiaries contribution to target price at 40 per cent given the conglomerate (holding company) discount. L&T has a 61 per cent stake in Mindtree while its stake in LTI and LTTS is at 74 per cent each.

The revival in spending across verticals (including covid-hit, discretionary) helped LTTS to continue the sequential revenue growth trend after the dip in Q1FY21. Revenues at $205 million (up 4.2 per cent quarter-on-quarter) have recovered to levels last seen in Q3FY20. Industrial products, transportation and plant engineering led the growth with sequential uptick in the 4.2-7.5 per cent while medical devices was the only laggard. 

Post the Q1 performance and demand recovery across geographies and verticals, the company increased its revenue growth guidance by 200 basis points to 15-17 per cent. Brokerages believe that FY22 growth can be higher. Analysts, led by Mukul Garg of Motilal Oswal Financial Services, say: “While we were expecting the guidance to increase, its strong 1QFY22 performance and commentary indicates that growth can significantly exceed the upper end of its revised guidance.”

The other positive in the quarterly performance was margin expansion both on a sequential as well as year ago basis. Analysts highlight operating profit margins expansion of 70 basis points (bps) on a sequential basis to 17.3 per cent way over the 15 per cent estimate of the street. A soft year ago base helped the year-on-year gain rise to over 500 bps. The gains came despite the wage hike impact of 150 bps and higher subcontractor cost. Though there will be residual wage hikes in Q2FY22, analysts at Kotak Institutional Equities expect margins to sustain at current levels aided by operating leverage from higher growth. 

While brokerages have increased the valuation multiple for the stock, the sharp price gains has made it one of the most expensive in the IT sector with valuations at 31.6 times its FY23 estimates. Await a correction and hold for the long term to benefit from the demand uptick in the niche engineering, research and development space.