L&T unlikely to meet FY14 sales guidance

Operating margins decline 56 bps to 8.5% on poor execution and high costs

Shares of engineering and construction heavyweight Larsen & Toubro (L&T) fell 7.64 per cent to Rs 902 on Monday, after the company reported a year-on-year (y-o-y) sales growth of five per cent in the first quarter (Q1) of FY14. The company's operating margins fell 56 basis points y-o-y to 8.5 per cent, which dragged net profit down by 16.2 per cent. While it is known that the first quarter is always weak for engineering and construction companies, L&T's poor showing in Q1 puts its full-year sales growth projection of 15 per cent at risk.

Although the company has retained its 15 per cent sales guidance, analysts are factoring in a revenue growth of no more than 10 to 13 per cent for the full-year, given the weak environment. Rupa Shah of Prabhudas Lilladher believes that given the weak Q1 numbers, the company could find it tough to meet its sales guidance of 15 per cent. If the company has to close the financial year with a sales growth of 15 per cent, it will have to grow revenues between 17 and 20 per cent for the remaining three quarters.

Analysts believe that even though the top line in Q1 was expected to be weak, the sharp fall in profitability is a bigger concern. Even though the first quarter is generally weak for engineering and construction companies, L&T's operating margins of 8.5 per cent in Q1 are a record of sorts. The last time margins went below nine per cent was in the June quarter of 2006-07, when operating margin dipped to seven per cent. Given that the company has geared up for a 15 per cent growth in sales and a rise in manpower accordingly, slow project execution has resulted in a negative operating leverage.

Building capacity and manpower isn't easy for the engineering and construction business and nor is it easy to scale down. If execution remains slow, the pressure on margins may persist. While one reason for the slow execution could be the early onset of rains, it may not entirely explain the slow execution, according to analysts. What is worrying is that the company does not expect the environment to change or improve over the next 12-18 months, even as order intake continues to be robust at Rs 25,000 crore in the first quarter of FY14. If execution and utilisation don't pick up, then, the pressure on profitability would persist. If revenue growth remains muted, margins would trend down to 10.5-10.7 per cent levels for the full year. The company ended last year with operating margins of 11.3 per cent.