L&T’s lower guidance leaves no margin for error

Larsen and Toubro Ltd’s management has lowered its expectations for the ongoing financial year, a decision that hasn’t gone down well with investors. 

Earnings for the March quarter and the 2023-24 financial year did have their share of positives, but lower-than-anticipated FY25 margin forecast for the company’s core project and manufacturing business played spoilsport. 

L&T’s shares plunged 6% on Thursday, deeper than the benchmark Nifty 50 index’s 1.6% fall.

The company’s FY25 margin guidance at 8.25% marks a steep revision from the 9% target the company had set for FY24 when the year had begun. This was a letdown for many analysts who were penciling in a 9-9.5% margin guidance. 

The management attributed several factors for the lower margin guidance. These included a changed order book composition with higher contribution from international orders, which tend to have lower margins; higher working capital requirement; higher fuel and labour costs, especially in West Asia; and deferment of claims.

L&T also cautioned of a possible variance in margin (estimated versus actual) due to these factors. Small wonder, earnings downgrades poured in and target prices for the L&T stock were slashed by a slew of brokerages. 

Kotak Institutional Equities cut its margin assumptions for L&T by 70-100 basis points (bps) for FY25 and by 70 bps for FY26, building in a limited 70 bps improvement in profitability over the next three years. One basis point is 0.01%.

This has overshadowed L&T’s strong close to FY24. The company’s order inflow growth at 31% year-on-year in FY24 was ahead of its 20% growth guidance. This provides robust execution visibility. 

While order inflows in the March quarter at Rs56,050 crore fell 8% year-on-year, led by a fall in domestic orders due to the ongoing elections, the order book at 4.8 trillion was at a record high. 

A moderation in domestic order inflows due to the ongoing national election may also weigh on L&T’s performance in the first half of this financial year. But the prospective pipeline for FY25 is healthy and stands at 12.1 trillion, up 24% year-on-year. Based on this, L&T anticipates 10% order inflow growth in FY25.

However, its FY25 revenue growth guidance of 15% seems low given the FY24 orders.

Further, the improvement in working capital situation aided by improved collections and better customer advances was a positive. This aided L&T’s return ratio profile. In FY24, L&T was able to improve return on equity (RoE) by 270 bps to 14.9% as it reduced net working capital by 410 bps to 12% of sales. 

For FY25, L&T expects net working capital to sales at 15%. The management said the company will constantly focus on improving RoE by reducing working capital. This will be driven by a better focus on overall collection improvement.

Meanwhile, the management said that average ridership in the Hyderabad Metro project fell to 441,000 passengers a day in the March quarter from 444,000 passengers a day in the preceding third quarter. The drop was due to free bus travel introduced for women by the Telangana government. 

L&T is looking to improve the operational parameters of Hyderabad Metro and considers reaching ridership exceeding 500,000 passengers before it can be sold to the private equity funds, which will take 18-24 months. 

L&T’s shares are down so far in 2024, underperforming the Nifty 50 index. The lukewarm margin performance seen in recent quarters despite robust order inflows has been a dampener. 

Analysts at IIFL Securities have cut their estimates for core FY25 and 26 earnings per share by 5% and 9%, respectively. They believe L&T’s FY25 guidance tames down earnings expectations, limiting further disappointments. In other words, meaningful upside in the stock ahead would depend on the trajectory of the company’s revenue and margin.

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