L&T Technology Services - 'Multiple' headwinds - ICICI Securities

H1FY21 result of L&T Technology Services (LTTS) once again exposed the relative vulnerability of ER&D (vs IT) to demand, supply and margin shocks. Further to a sharp fall in revenue/profitability in Q1FY21, modest recovery during Sep-20 (that too led by unreliable markets like RoW, India) was underwhelming. While LTTS hinted at 40% increase in the pipeline (vs Dec-19), quick conversion into deals/revenue may be a tough ask. Post Covid-19, (1) reprioritisation of capital, (2) focus on increasing utilisation of existing assets and (3) elongation of product development cycles underpin this assessment. Even after factoring in EBIT margin of 16.5% (vs aspirational 17%) by FY22, multiples appear lofty (25x on FY22E EPS subject to export incentives). As IT passed the acid test of Covid-19 on resilience, continuity and longevity, our valuation framework (note) suggests ~40% premium valuations vs pre-Covid are understandable. However, LTTS' multiples should not change much as the benefit of fall in COE (+20%) should be offset by the reversal of the growth premium (-20%). We downgrade our rating to REDUCE with a target price of Rs 1.550.

- Underwhelming recovery post a sharp fall in revenue and profitability. Revenue growth of 2.9% QoQ (CC) was underwhelming for two reasons - (1) was majorly led by unreliable and non-core geographies like RoW and India (24% of revenue), (2) came on the back of a sharp revenue decline in Q1FY21 (-13% QoQ, CC). In key segments like transportation and plant engineering, where the company lost nearly a quarter of revenue in the previous quarter, recovery has been modest at best. Gross margins expanded 330 bps QoQ led by a sharp increase in utilisations. However, spike in SG&A expenses restricted EBIT margin expansion to mere 160 bps QoQ.

- Deal pipeline was stated to be ~40% higher. However, conversion is key. (1) Reprioritisation of capital, (2) focus on increasing utilisation of existing assets and (3) elongation of product development cycles across industries make us sceptical. Adjusted for CC and inorganic benefit, FY21 revenue guidance does not seem to change much (vs Jun-20). Management hinted at an aspirational EBIT margin of 17%.

- The erstwhile premium multiples should now face headwinds. Pre-Covid, LTTS, on an average, was commanding at least ~25% premium over comparable IT companies. This was attributed by the consensus to (1) higher growth potential over long term and (2) scarcity of listed ER&D pure plays. However, Covid-19 necessitated a relook at these assumptions. As detailed in our sector thematic, our valuation framework suggests a 40% premium in IT valuations post Covid (vs pre- Covid averages) is understandable. However, multiples of LTTS should not change much as the benefit of fall in COE (+20%) should be offset by the reversal of growth premium (-20%) it was commanding. We value the stock at 20x Sep-22E EPS.

Shares of L&T Technology Services Ltd was last trading in BSE at Rs.1750.55 as compared to the previous close of Rs. 1728.8. The total number of shares traded during the day was 13622 in over 1871 trades.

The stock hit an intraday high of Rs. 1779.8 and intraday low of 1693.95. The net turnover during the day was Rs. 23602849.

Source : Equity Bulls

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