Slow execution could hit L&T's FY16 sales

Analysts cut earnings estimates despite growth in order inflows

Infrastructure investment is picking up but bottlenecks continue to hinder execution. Larsen & Toubro (L&T), India’s largest engineering and construction company, exited FY15 with robust growth in order inflows, but revenue growth remained tepid, as projects continued to see bottlenecks. Analysts expect this to persist in FY16.

The company reported 22 per cent growth in fresh order inflows in FY15, led by a 40 per cent year-on-year increase in orders in the March quarter. Fresh orders have picked up in the roads, power and buildings segments. The company expects revenue to grow 15 per cent in FY16. Explains IIFL Institutional Equities: “With little on-ground improvement in various bottlenecks to execution, FY15 consolidated revenue growth was lower than expected at eight per cent.”

The disconnect between revenue growth and order inflows is evident from the company’s revenue and order estimates of 15 per cent for FY16. Order backlog has risen 28 per cent to Rs 2,32,600 crore, 2.5 times the trailing revenue. Despite this, the company has estimated revenue growth of 15 per cent this financial year, as it doesn’t expect de-bottlenecking before FY17. HDFC Securities expects the investment climate to revive gradually, as the government takes steps to ease execution and open sectors such as defence and railways to private investment.

L&T has made large investments in adding capacity in ship building, forging, heavy engineering and power. However, these capacities have remained under-utilised, as orders were weak. The company’s consolidated operating margin stood at 12.3 per cent, owing to losses in these segments. The company expects losses to reduce and margins to improve. The Street believes L&T will be able to improve margins by 100 basis points in FY16, according to its estimate. Losses in the hydrocarbon segment, which stood at Rs 1,130 crore, are expected to decline, as most projects with cost-overruns will be completed in the first half of FY16. Analysts say if losses in the hydrocarbon segment don’t persist, L&T could boost margins by 100 basis points this year.

Given the challenges to project execution, the Street is divided on L&T’s revenue and earnings prospects. While some analysts believe revenue growth could surprise on the upside, which would improve earnings, others say challenges will persist through the year. HDFC Securities has reduced its earnings estimates for FY16 and FY17 by eight per cent and four per cent, respectively, due to a slower pick-up in execution. However, most brokerages have retained a positive stance on the stock, as it is expected to benefit from a revival in investment.