Stock Pick From The Infrastructure Sector

HERE IS WHY:

• A strong order inflow (up 27 per cent in H1FY14) indicates an improvement in its business.
• A focus on international orders is helping the company sustain good cash flows.
• The infrastructure segment likely to be the major growth driver, with the domestic order book expected to perk up in H2FY14.

The infrastructure sector has been witnessing a difficult scenario for the past two years. Factors like slower economic growth, a halted capex cycle and higher interest costs making projects financially unviable has made the infrastructure companies struggle to perform. The aggressive bidding on account of intense competition has eroded the margins.

However, this is the scenario which separates the men from the boys. And engineering major L&T has proved time and again which set it belongs to. In a situation where most of the other infrastructure companies are finding it difficult to stay afloat, L&T has carved its own path by defying all the obstacles. If the Q2FY14 financial numbers are anything to go by, the scrip makes a strong case for investment.

There are many encouraging takeaways from the company’s latest set of results. The ghosts of a disappointing Q4FY13-Q1FY14 are left behind as far as the company’s financial performance is concerned, as the Q2FY14 results seem to have sown seeds of a turnaround in fortunes.

The order inflow for H1FY14 is up by 27 per cent to Rs 51700 crore as compared to Rs 40600 crore in H1FY13. This has resulted in the order backlog for H1FY14 increasing to Rs 176000 crore as compared to Rs 158500 crore in the corresponding period of the previous year. The order inflow has been majorly led by the international order book. Of the total order inflow for H1FY14, 29 per cent is from the international markets.

In fact, the management has stated that growing international order book will be a boost for the company, despite having EBITDA margins 200 basis points lower than the domestic book. It generates a steady cash flow, which is the need of the hour when the cost of funds has increased significantly. Going ahead, the company is also looking for more international exposure in CIS countries. On the domestic front too, the scenario is likely to improve, with the government putting infra projects on fast track. However, the management has said that it will take around two quarters till those orders start ticking in its order book.

The declining EBITDA margins are a spot of bother for the company. For H1FY14, this stood at 9.10 per cent as against 9.80 per cent in H1FY13. However, one needs to understand that the half yearly margins are not indicative of its performance. Margin booking depends on the completion cycle of the project, with higher numbers being seen towards the completion of projects. Apart from that, the under-utilisation of capacities in the hydrocarbons and metal business has added to the woes. But we expect the margins to improve going ahead on account of declining commodity prices. Further, as the domestic orders start pouring in, the margins would see an upward bias as the higher utilisation of capacities would add some benefits.

If we take a look at the different segments, infrastructure is driving the company’s growth. As much as 67 per cent of the order inflow and 69 per cent of the order book for H1FY14 consists of infrastructure projects. This is one segment which has managed to sustain its EBITDA margins at 12.70 per cent (12 per cent in H1FY13 and around 11.40 per cent in FY13). Going ahead, we expect the infra segment to help growth, with the remaining segments posting a muted performance.

As far as its financial performance goes, the company posted a topline of Rs 27065 crore in H1FY14 as against Rs 25151 crore in H1FY13. The EBITDA stood at Rs 2474 crore, marginally down from Rs 24.88 crore previously. We believe that a 20 per cent revenue growth in H2FY14 will be a commendable job in an environment wherein L&T’s peers would be seeing massive earnings deterioration. An uptick and consistency on the margins front will also be a positive as we believe that the perception of low margins in the infra segment are steadily receding. On the valuations front, the scrip is trading at 18x its FY14E earnings. We recommend buying the scrip at the current levels with a target price of Rs 1070 over the next one year.