We are increasing our fair value to Rs 1,650 per share from Rs 1,200 per share. Around Rs 250 is attributed to a change in Morningstar's global cost of capital assumptions, Rs 170 to our change in forecast, and Rs 30 with regards to the time value of money.
The increase in our five-year free cash flow forecast reflects monetisation of stakes in its subsidiaries and toll projects. This 3-star rated stock is fairly valued with shares trading slightly above our fair value estimate.
We have been conservative on L&T's operational performance as the core operating environment continues to remain subdued. This is reflected by the elevated working capital requirements (26% of sales) for L&T and lack of significant announcements of new capital commitments from the industry. However, L&T’s ability to increase its order backlog consistently despite a weak investment cycle showcases the benefits it enjoys owing to its diverse presence across segments and geographies.
The average order inflow for the first nine months stands at Rs 359 billion, up 25% versus same period last year. This has increased the order backlog to Rs 2.2 trillion, giving us more than two years of revenue visibility. We are more enthused about the prospective bid pipeline of about $100 billion in the defence, power and infrastructure sectors and believe L&T would be able to maintain a double digit win ratio in the above segments at present.
The third quarter profit disappointment was largely due to higher losses in international hydrocarbon orders. Therefore, shipbuilding, hydrocarbon and other manufacturing segments would continue to act as drag for the near term profitability. However, higher probability of winning defence contracts coupled with service business will push the group operating margins higher which will be incrementally positive for the returns on invested capital.
Moat
We maintain our no-moat rating, as L&T operates in a price competitive industry where we do not believe attractive rates of return on invested capital can be consistently delivered long term. Our high uncertainty rating reflects increasing exposure to international contracts where L&T has a limited operating track record.
