Investors  as  macro  gloom  worsens the L&T stock runs out of favour.

L&T’s valuation of 14 times 1-year forward earnings is below the decadal average of more than 20 times
Earnings risk is due to deteriorating macroeconomic trends, order outlook, execution challenges

Larsen and Toubro Ltd’s (L&T’s) shares are hovering around a three-year low. This column had earlier pointed out that the stock does a better job at reflecting the woes of the economy compared to market indices, which are still flying high on account of a handful of stocks.

But while the Nifty and the Sensex are riding high on optimism, the L&T stock may be receiving more than a fair share of pessimism. After all, why should shares of the diversified conglomerate, flush with an order book that is almost three times its annual revenue, face a derating? Its one-year forward price-earnings multiple of 14 is way below the decadal average of more than 20 times earnings.

While the company reported fairly strong order flows, alongside decent revenue and profit growth in the December quarter, even this has failed to prop up the stock.

There is little doubt that bad news abounds. A recent report by Emkay Global Financial Services Ltd said: “Most companies in our engineering and construction universe highlighted deteriorating macroeconomic trends and strained government finances, affecting order outlook, execution challenges and working capital stress emanating from a tightened liquidity situation.”

Besides, there were hardly any big tender awards in January even in the infrastructure sectors such as roads, railways and power, while private sector announcements, too, were dismal. Note that even in the third quarter of FY20, about 43% of L&T’s order flows accrued from international markets, whereas many large domestic orders were deferred.

What’s more, the coronavirus outbreak in global markets has put the company’s international orders at risk. “International ordering may remain cloudy owing to falling crude oil prices and disruptions led by the outbreak of coronavirus,” said Umesh Raut, senior analyst (capital goods) at Yes Securities (India) Ltd.

Besides, the liquidity crunch continues to hurt the domestic economy as well. “The environment is not conductive to faster execution of projects,” added Raut. Hence, investors are doubtful about the company achieving its FY20 guidance of 10-12% order flow growth, and 12-15% revenue growth.

But there is a silver lining in this gloomy outlook. The fall in the stock appears to have been priced in these negatives. “We believe L&T’s share price reflects those few times when risk-reward is favourable, with downside protection from gradual execution ramp up and upside from recovery off a low FY19-20 capex base,” said a report by Jefferies India Pvt. Ltd.

Besides, the management has used its balance-sheet heft in the past to help vendors wade through challenges. For instance, working capital rose to about 23% of sales in Q3 FY20, as a result of supporting small vendors complete projects on time.

But for investor sentiment to improve, news flow will need to improve, as the L&T stock has clearly run out of favour with the Street.

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