Stock call: Buy Larsen & Toubro Infotech with target price of Rs 1,905

We had downgraded L&T Infotech (LTI) post Q3FY19 results (Limited catalysts for re-rating) given client-specific issues, peak margins and near full valuation. Stock is since down ~9%, which appropriately captures our concerns. NIFTY IT index is up 4% in comparison. We also see it less likely for any stake acquisition in Mindtree, if at all, to happen from LTI’s balance sheet. As a result, we upgrade the stock to ‘Buy’, with a revised target price of rS 1,905 based on 18x FY21E EPS.

One key hallmark of growth for LTI in 9MFY19 has been its broad-based nature across client buckets. Revenues at top 5, top 6-10, top 11-20 and non-top-20 clients increased by 15.3%, 24.2%, 24.6% and 24.1% respectively in 9MFY19. Likewise, execution has been strong across all its key strategic imperatives.

Superior execution and broad-based nature of growth leads us to project revenue growth of 14% in FY20 despite likely weakness at the largest BFS client. In addition to client specific ramp-down, revenue growth in Q1FY20 is expected to get impacted on account of absence of pass-through of licenses and hardware, especially related to India revenues. However, we still expect sequential growth to be positive at 1-2% QoQ in Q1FY20E. Revenue growth should pick up sharply from Q2FY20 with visibility backlog driven with ramp-up of the Nets deal to help as well.

EBIT margin for LTI has increased for six consecutive quarters from 14.4% in Q1FY18 to 19.1% in Q3FY19 aided among other things by the sharp depreciation in INR in 9MFY19. However, we expect EBIT margin to decline in the range of 100-150bps QoQ in Q4FY19 because of capacity creation, localisation and investments in sales & marketing. For FY20, we expect EBIT margin to decline by 80bps to ~17.6%. Improvements in pyramid and fixed-cost absorption are expected to be the primary offsets to the headwind from wage hikes apart from investmentcentric margin drags. Wage bill for fresher’s is also likely to be higher in FY20 as nearly a quarter of campus hires who will join in FY20 are from better pedigree institutes like NITs (National Institutes of Technology). Management remains confident of sustaining NPM at 15% even in FY20.

Larsen & Toubro Limited