L&T’s great swing from infra to tech

The L&T of the future, however, could look very different from its past.

Larsen & Toubro is a huge conglomerate. It provides quarterly performance for nine different segments- infrastructure, heavy engineering, power (construction of thermal plants), defense (including aerospace and shipbuilding), hydrocarbons, concession-based development projects (metropolis, roads, etc.), information Manages and reports on data. and technology (consisting of the separate listed businesses L&T Infotech, L&T Technology Services and Mindtree), financial services and a diverse group of everything else under “others” (real estate, industrial products, smart city projects, etc.). Most of these businesses operate in about 30 countries other than India.

Given this complexity, the L&T machine works much the same way as India did under its predecessor, the Planning Commission. It consists of long-term “perspective” plans of periodic 7-10 years which are broken down into smaller strategic five-year plans titled ‘targets’, which are then subdivided into annual goals.

The most recent target FY16-21, aimed at improving margins and doubling sales while divestment of non-core assets, coincides with the transfer of management control from group chairman AM Naik to his dependent and current chief executive. SN Subramaniam. Trained as a civil engineer, SNS (as he is referred to both within and outside L&T) rose through the ranks as an infrastructure and construction specialist. As CEO, however, he had to steer an infra company through a continuing decline in funding from his primary client—the union and state governments.

The central planning structure has shaped L&T’s history over the past few decades, allowing it to move into new business verticals (such as its emphasis on IT) to stay ahead of the game and in the past for basic asset ownership. exiting. Once a few years such structures became poisonous.

While COVID has delayed the new target announcement, the company’s recent performance metrics and several new investments are a sign of what SNS is thinking: the bulk of L&T’s growth prospects could be outside its traditional infrastructure paradigm .

IT beats Infra

Revenues from L&T’s traditional strongholds- infrastructure, hydrocarbons, power, defence, development projects have declined over the past five years, as have their profit margins. In contrast, revenues from its three major IT subsidiaries are contributing to the bulk of the consolidated topline, especially after the acquisition of Mindtree.

“The goal is… to increase the share of IT businesses in the overall revenue mix from the current 20%,” SNS told Mint.

The difference in performance is evident when one looks at the pre-tax profit break-up; IT and technology subsidiaries reported over 45% profit in the first half of FY12, rising from 33% at the end of the previous fiscal. The contribution of infrastructure declined from 31% in the previous fiscal to 24% in the first half of FY22 in the same period.

Abhishek Shukla, associate director, India Ratings & Research, said, “L&T is fast becoming a service, not just an infrastructure, company. Even though they are not emphasizing on infra as a segment, the fact remains That IT subsidiaries form a major part of L&T’s margin profile is now changing the nature of the company.”

In fact, the earnings growth from L&T’s IT subsidiaries is particularly impressive, given the steady sale of “non-core” assets by the company in the target FY 16-21 period, some of which contributed to the services division. Have given.

These disinvestments included the sale of L&T’s general insurance arm to Blackstone Group LP in 2016 to HDFC Ergo and Seawoods Grand Central Mall in Navi Mumbai. The largest disinvestment in this period was the outright cash sale of its electrical and automation division to Schneider. for electricity 14,000 crore last year. Recently, in August, it sold its 99-MW hydroelectric power plant in Uttarakhand to ReNew Power 985 crores.

L&T established the Infrastructure Development Projects Limited (IDPL) division in 1995 to incorporate the parent company’s Build-Operate-Transfer (BOT) assets and portfolio of public-private partnership projects, including highways, bridges, sea ports, Transmission lines include wind power. and metro rail projects. Many of these projects have now been placed or sold as part of infrastructure investment fund IndInfravit. Since 2014, Canada Pension Plan Investment Board has acquired a 49% stake in IDPL, which now primarily has road projects and power transmission lines, while L&T expects to exit the venture completely by 2023. is, and with it, most of its development interests.

The two big assets that are difficult for L&T to sell in the market are the 1400-MW The Rs 9,000-crore Nabha Thermal Power Project in Punjab and the loss-making Hyderabad Metro Rail Project (L&T’s biggest project investment) 18,000 crore). Nabha’s sales have been hit by a glut of thermal power plants in the market after 2017 after cleaning up of bad loans by banks and reluctance of foreign funds to buy coal power due to carbon-neutral targets.

The first phase of the Hyderabad Metro line became fully operational in February 2020, just a month before the country went into a strict COVID lockdown. Metro Rail Assistant reported the loss of 1,767 crore in FY21.

However, things have started showing up in this financial year. In Q1 FY22, L&T reported that the average Metro ridership was around 55,000 passengers a day; This figure had quadrupled by October, with an average of 190,000 to 200,000 passengers per day. In the second quarter earnings call with stock market analysts, P Ramakrishnan, head, investor relations, L&T said the company is evaluating several options to make the project sustainable. Its grace period of 60 years will also, hopefully, make it an attractive prospect for investors.

Few local buyers for NMP

L&T’s continued efforts to turn its balance sheet asset-light are ironically coming to an end at a time when the government wants the private sector to expand its ownership of infrastructure assets.

Through the National Monetization Pipeline (NMP), the government hopes to mobilize 6 trillion by 2025 by selling off many publicly owned properties. L&T’s activity in the infrastructure sector is often seen as a proxy for the broader market; The decision to remain asset-light, avoid locking up capital in long-term concessions and move towards a new service direction does not bode well for the government’s plans.

“With the experience of infrastructure companies over the past two decades, we now know that there is a certain risk associated with property ownership.[From these range]erroneous traffic assumptions and judicial orders forcibly revoking a power purchase agreement against you. : Let’s go for talks,” Shukla of India Ratings said. “Historically, we used to believe that real estate companies (land) want to deposit banks and that infra companies (want) want to own assets. We are seeing the opposite happening now, the lean balance sheet has woken up. “

“I believe that overall, the infrastructure sector is moving in a direction where long-term financial investors like private equity or sovereign wealth funds will have assets,” Shukla said. Competitive advantage by accurately estimating the number of (future) users and accessing cheaper capital. You really don’t need the technical expertise to build in-house.”

Nilesh Bhaiya, Equity Research Analyst, Motilal Oswal Financial Services, said, “If you take a 3-5 year view of the Indian economy, with private and public capital expenditure set to pick up, L&T is your best game. ” “L&T is now a pure EPC (Engineering, Procurement, Construction) game, with no BOTs, no hybrid annuities on the roads, etc. Hence, as the macro economy starts to do better, L&T’s core business will also grow “

“Meanwhile, IT subsidiaries ship to L&T steady even pre-Covid, when capital expenditure slowed down. The price-to-earnings multiplier of the core business is about 13 times; IT subsidiaries nearly 40 times,” Bhaiya said. “Look at L&T peers a decade ago—Punj Lloyd, Supreme Infra, HCC, GMR, GVK, JP, Lanco Infra, Gammon, and many more now struggle to survive are doing. , So, even though the company is more inclined towards IT and services, for an investor, it is still a good infra bet.”

a new direction

Once Nabha Power and Hyderabad Metro are shut down, L&T will be more or less debt free for a company of its scale (except for approx.) 90,000 crore loan on the account of the lending arm, L&T Finance). Today, it’s about 26,000 crore in surplus cash and by all indications, Target 22-27 will invest deeper into the services sector.

October saw the launch of L&T Edutech, whose group chairman AM Naik said it “will train engineers with the wealth of knowledge and expertise (L&T) gained from executing some of the most complex and demanding projects over the past decades.” Sufin, an e-commerce platform to ease supply chain and finance management for small and medium businesses, is expected to be launched later this financial year.

Company watchers believe engineering and services aimed at energy transformation will gain prominence, given L&T’s water neutrality (2035) and carbon neutrality (2040) goals.

In an email interview with Mint, SNS said: “In the future, the company will look at green offerings by looking at ways to get into the manufacturing of electrolysis equipment and stationary batteries for grid stabilization. We look forward to providing services on the green hydrogen front.” We also intend to consider partnerships with renewable energy companies.”

A senior Mumbai-based infrastructure analyst told Mint on condition of anonymity that the infrastructure capex cycle is unlikely to recover any time soon. “I think this is part of the reason why they (L&T) have decided to go all-in on tech. Even up to two years ago, IT and tech did a lot on the part of the L&T stable. It was an attractive offering. The hostile takeover of Mindtree in 2019 is part of this new aggression and now, around 50% of the current stock price is based on IT subsidiaries,” said the analyst.

He said, “The market already sees L&T as an IT play apart from an infra play. L&T itself clearly sees its future in technology and finance, and I think its legacy as an infra company will change.”