Maintain ADD on L&T Technology Services - Enduring the ebbs and flows - HDFC Securities

Mr. Apurva Prasad & Mr. Amit Chandra, Institutional Research Analyst, HDFC Securities.

L&T Technology Services (Q4FY20): Enduring the ebbs and flows. Maintain ADD
(TP Rs 1,125, CMP Rs 1,068, MCap Rs 111bn)

Maintain ADD on L&T Technology Services (LTTS) with in-line operating performance and lower rev in 4Q. While weaker cash conversion and high susceptibility to deferral in discretionary projects are negatives, (1) Leadership within ER&D segment (consolidation opportunities), (2) Recovery in deal pipeline to pre-COVID levels, and (3) Diversified client & vertical base mitigating the volume compression in high-impact verticals are positives. Our TP of Rs 1,125, at 14x FY22E EPS (~7% cut in EPS).

Short term growth trajectory impact, offset by uptick in deal pipeline: LTTS posted revenue of USD 195.4mn, -1.1/+3.4% QoQ/YoY CC impacted by steep decline in the Plant Engineering vertical (Oil & Gas sub-segment) on account of abrupt project closure and softness in Transportation vertical. Delay in project ramp-up and deferral in long-tenured projects are likely to impact the short term trajectory, despite an uptick in deal pipeline to pre-COVID levels. Deal wins in Apr/May period can support recovery beyond the 1Q decline, apart from ramp-up of strong wins from 4Q (USD 30mn+ TCV deal and 3 deals in USD 10-20mn TCV range). FY20 revenue growth was 9.3% CC.

Near term outperformance of Telecom & Hi-tech and Medical verticals: Telecom & Hi-tech vertical and Medical devices vertical are expected to outperform in the near-term based on relative resilience (semiconductor/M&E strength) and deal wins in the segments (4 in Telecom & Hi-tech). Plant engineering is expected to languish longer with continued impact in its Oil & Gas sub-segment (volume/budget cuts), partly offset by its CPG/Specialty chemicals sub-segments.

Revenue-mix shift and operating de-leverage headwinds to margin: EBIT margin stood at 15.2%, -161bps QoQ (16.5% adj. for one-time CSR component of Rs 0.18bn). Shift towards lower-margin Telecom & Hi-tech and decline in revenue are margin headwinds. PAT was supported by higher other income led by forex gain and export license incentive. Cash generation deteriorated in FY20 (21% drop in OCF in FY20) with increase in DSO from 76 days in FY19 to 90 days in FY20 and increase in unbilled revenue.

Valuation and view: We've factored USD rev/APAT decline of 4.3/8.1% with margin decline of 100bps, with growth divergence across segments Plant Engg./Medical Devices growth at -16/+23% in FY21. Subsequent recovery in rev growth at 11.5% and operating margin reverting back to FY20-levels is built-in for FY22. At CMP, LTTS trades at 16.2/13.3x FY21/22E at a discount to its historical avg. of 19x. While a diversified vertical portfolio is a key differentiator, the broad-based economic impact dilutes the moat (higher impact in Plant engineering, Industrial and Transportation).

Shares of L&T Technology Services Ltd was last trading in BSE at Rs.1069.9 as compared to the previous close of Rs. 1114.65. The total number of shares traded during the day was 10959 in over 2654 trades.

The stock hit an intraday high of Rs. 1123 and intraday low of 1066.45. The net turnover during the day was Rs. 11876859.

Source : Equity Bulls

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