What L&T’s Q1 result tells us about state of investment demand in Indian economy

The worst is certainly behind L&T, but when private sector investment demand will gain momentum is still an open question. Graphic: Mint

As India’s largest infrastructure and engineering conglomerate, Larsen & Toubro Ltd is proxy for the state of investment demand. The company’s June quarter’s media release on its performance has many takeaways.

Fresh order intake fell 11% to Rs26,400 crore. But this is not a reflection on domestic demand. The drag came from low international orders which reflect a subdued investment environment in its key market—the Middle East. However, domestic orders were mainly from government quarters and from services. L&T’s management said that bank credit to industry was subdued and the orders came from public expenditure.

This clearly shows that capex cycle on the industrial front is yet to pick up. In a sense, the weak order book and revenue accretion in the heavy engineering segment also mirrors this.

Another takeaway is that one can see some green shoots of recovery in improved orders in infrastructure, which comprised 57% of total orders bagged in the quarter. This compares to 40% twelve months ago. Revenue from this segment rose 16%, but then profitability dropped by 110 basis points (bps) from a year earlier. The firm’s media release said that this was due to delayed approvals and extended stay on some projects and product mix, indicating the sluggish macroeconomic milieu.

One cannot ignore the declining importance of the power generation, given the surplus capacity, stalled projects and weak plant utilization. L&T’s power segment orders were negligible and margins declined to 1.3% from 5.8% a year ago.

Further, that services including financial services comprises almost a fifth of its consolidated revenue shows two things. One, that the economy is holding out in these areas amid the overall core industry slowdown. Two, it shows that the L&T is nimble-footed enough to cash in on growth areas. Besides, the firm’s revenue growth met forecasts although its 46% jump in net profit was still lower than Bloomberg’s average estimates.

The concern, however, is that L&T’s operating profitability has slipped into single digits—a pointer to pressure on cash flows as is the case for most firms in the engineering and infrastructure arena.

Meanwhile, the management has stuck to its guidance of 12-14% growth in orders, 12% in revenue and 25-50 bps improvement in operating margin for FY18.

The strong order pipeline that should materialize in FY18 supports the guidance. It also puts the economy in a more positive light compared to FY17 backed by other macroeconomic growth indicators like lower interest rates, good monsoon, higher consumer spending from Pay Commission-linked salary hikes—all of which should add momentum to the economic cycle.

The worst is certainly behind L&T, but when private sector investment demand will gain momentum is still an open question.