L&T's margin expansion in third quarter surprises Street

Firm maintains 15% revenue growth guidance but analysts say that's tough as revenues grew 9% in Apr-Dec

For the past several quarters, the Street has been factoring in some negative surprise from Larsen & Toubro (L&T), India’s largest infrastructure company. However, L&T has posted a revenue growth of 12 per cent, after adjusting for the de-merger of its hydrocarbon business, a 180 basis points (bps) jump in operating margins and a 22 per cent growth in order inflows. With the Bombay High Court approving the de-merger on December 20, 2013, L&T has re-stated its financials for the first nine months of FY14.

Analysts say L&T was compelled to de-merge the hydrocarbon business as it was a drag on overall numbers. After adjusting for the de-merger, L&T’s gross revenues for April-December 2013 have grown nine per cent to Rs 36,934 crore. The firm has not revised its 15 per cent revenue growth guidance (forecast) for FY14, though.

With de-merger of the hydrocarbon business, which accounts for 10 per cent of total revenues, L&T would now have to clock revenues of Rs 61,000 crore to meet its guidance, against the earlier estimate of Rs 69,000 crore. This implies the firm should have revenues of Rs 24,000 crore in the fourth quarter.

Analysts believe this could be a stretch, given that L&T’s revenues in the December quarter have grown by 12 per cent to Rs 14,534 crore and nine per cent in the first nine months of FY14. Viral Shah of Angel Broking says the healthy growth in revenues was driven by strong execution in engineering and construction orders and improved execution in international orders.

On the positive side, the de-merger has aided margins, as the hydrocarbon business has been a drag on margins. In Q3, L&T's operating margins have shown a marked improvement, rising 186 bps, year-on-year, to 11.6 per cent, which is well ahead of estimates. L&T might be able to maintain margins between nine and 11 per cent. It has reported a good growth in order inflow, giving revenue visibility for the next two years, but the market believes the firm is getting business at the cost of profitability. Currently, the stock is trading at 15x its one-year forward earnings and analysts believe the upside may be capped.