Nomura initiates coverage on L&T Tech with ‘reduce’ rating, cuts target price, expects 100 bps margin contraction

Nomura expects around 4 percent USD revenue CAGR over FY22-25F with a 100 bps margin contraction, leading to a 15.2 percent earnings per share (EPS) CAGR.

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Shares of L&T Technology Services were trading lower by 2 percent in the morning session on March 2 after research firm Nomura initiated coverage on the stock with a ‘reduce’ rating.

The Japanese research firm Nomura has initiated coverage on the stock with a reduced rating and has a target price of Rs 3,050 per share, a downside of around 20 percent from the current market price.

At 11:32 hours, L&T Technology Services was quoting at Rs 3,695, down Rs 55.70, or 1.49 percent on BSE. It has touched an intraday high of Rs 3,714.80 and an intraday low of Rs 3,661.

According to Nomura, global engineering research & development (ER&D) total spending was $1.3 trillion in CY21, and expects the Everest Group to record a compound annual growth rate (CAGR) of around 6.6 percent over CY21-24E, led by digital engineering services (12.4 percent CAGR) as enterprises continue to revamp products, services and processes.

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“Everest Group expects outsourcing, which accounted for around 9 percent of the overall spend in ER&D in CY21, to rise, led enterprises’ focus on ramping up go-to-market strategies, the transition of outsourcing partners from implementation and support partner to innovation driver and continued supply-side headwinds,”  Nomura said.

“In CY21, among the top 50 ER&D service providers, broad-based players recorded around 21 percent YoY growth in ER&D services against pure-play players’ around 11 percent YoY growth, indicating marketshare gains for the former,” the research firm added.

According to Nomura, there is a strong correlation between L&T Tech’s segmental and overall revenue growth and T200 companies’ ER&D spend growth over the CY18-21 period.

Bloomberg consensus revenue growth estimates for T200 companies, including transportation, industrial products, telecom & hi-tech and medical devices verticals, indicate a weak growth outlook of 3.4 percent YoY in CY22 and 3.3 percent YoY in CY23, against the 14.5 percent YoY revenue growth reported in CY21.

“L&T Tech leads in India’s pure play ER&D space with one of the most comprehensive sets of portfolio, deep domain expertise across key verticals from internal/external investments, an impressive set of clients across verticals and high digital revenue contribution (56 percent in FY22),” it said in a research note.

Larsen & Toubro earlier announced that its tech arm L&T Technology Services will acquire its Smart World and Communication (SWC) business. L&T’s Smart World and Communication business has an annual revenue of Rs 1,000 crore with a networth of Rs 440 crore.

Nomura expects around 4 percent USD revenue CAGR over FY22-25F with a 100 bps margin contraction, leading to a 15.2 percent earnings per share (EPS) CAGR.

“The target price of Rs 3,050 is based on 22x FY25F EPS. Our FY23-25F EPS are 2-8 percent lower than consensus. L&T Tech trades at 26.4x FY25F EPS, which we believe is expensive with risks including higher-than-expected revenue growth and sharp margin recovery after the SWC acquisition,”  Nomura added.

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