Brokerage firm Kotak Securities has downgraded the stock of L&T Technology Services (LTTS) to a 'sell' from a 'reduce' with a fair value (target price) of ₹3,050.
The brokerage firm has attributed the downgrade to the expensive valuations of the stock which is at 32 times FY2024E earnings per share (EPS).
"We downgrade LTTS to a 'sell' from a 'reduce' following a 20% rally in the stock price recently. The stock does not offer a margin of safety even after baking in elevated growth at peak margins (18%)—multiples at 32 times FY2024E EPS are rich," Kotak Securities said.
The brokerage firm highlighted that engineering, research and design (ERD) spending is discretionary and sensitive to changes in economic cycles. This was visible in past cycles and FY2021, where Covid led to a sharper decline in revenues of LTTS relative to peers.
"We have increased our EPS estimates by 2-3% largely on change in INR/USD assumption to 80-81 from 77-79 earlier; we have also baked in an additional cross-currency impact, resulting in a cut in USD revenue growth estimates to 13.1% for FY2023E, even as our constant currency (CC) revenue growth assumptions remain unchanged. Our fair value of ₹3,050 is based on 24 times (unchanged) June 2024E EPS (March 2024E earlier)," said Kotak.
Kotak said the impact of the slowdown is visible in a few segments. LTTS derives 20% of revenues from telecom and hi-tech and 11.5% from medical devices.
Client-specific project delays or pauses are emerging in a few pockets, mainly in several subsegments of the telecom and hi-tech vertical—consumer electronics, telecom operators, telecom infra and ISVs. Demand has the possibility of slowing down even in the semiconductor subsegment.
Kotak said that clients generally are reluctant on projects with longer payback periods and riskier bets. A few clients in medical devices have also tightened budgets. Of course, these concerns are partly baked into the current estimates. We bake in moderate revenue growth of 8.4% in FY2024E compared to 13.1% in FY2023E (16% in CC). LTTS has guided for 13.5-15.5% revenue growth in USD terms for FY2023E.
As per the brokerage firm, LTTS expects FY2023E EBIT margin to be 18%+, largely unchanged from FY2022 levels.
Margins in the past have trended between 13% and 16%.
Improvement in margins has been courtesy of elimination of low-margin contracts, change in the mix of business, rationalization of tail accounts (in the past) and success in infusing freshers into programs.
"LTTS expects to maintain 18%+ EBIT margin in FY2023 with levers from higher utilization, offshoring, pyramid and mix change to higher-margin business. Margin confidence will be tested in the phase of a slowdown. We forecast margins in the 17.5-18% range for FY2023-25E," said Kotak.
Disclaimer: The views and recommendations given in this article are those of the broking firm. These do not represent the views of MintGenie.
