Larsen & Toubro Ltd (L&T) is in a sweet spot. An upbeat environment enables it to ‘pick and choose’ projects, giving it a fair amount of pricing power. On the other hand, efficiencies in material sourcing have helped it cut costs considerably. The upshot: a near 300 basis points increase in operating margin, which caused operating profit to jump 67% last year. Considering that L&T’s margins stood at 7% last year, the three percentage point increase is significant.
Net profit adjusted for exceptionals rose 60% to Rs1,385 crore. The combined profit of L&T’s subsidiary companies also increased by 60% to Rs455 crore. The market seems to have anticipated this improvement—since January, L&T shares have risen by 28%, compared with a mere 8% rise in the National Stock Exchange’s Nifty. But the anticipated growth in profit was only one reason the markets were excited. The firm’s order inflow increased by 37% last year to Rs30,600 crore. Outstanding orders jumped 48% to Rs36,800 crore. Given the strength of its order book, L&T expects revenues to grow 25-30% in FY08. Sales grew 20% in FY07.
While earnings grew by more than 60% last year, the increase in the capital employed by the company was much lower. As a result, return on capital has also improved by three percentage points to 20.4%.
Adjusted for the value of its stake in infrastructure subsidiary L&T-IDPL (L&T Infrastructure Development Projects Ltd), L&T is valued at about 21 times trailing consolidated earnings. This looks reasonable, considering the 25-30% growth expected in the near term. But at the same time, the stock can’t be expected to jump substantially, given that L&T’s is a cyclical business.
Less than a month ago, at an analysts’ meet after announcing their results, the India Infoline Ltd’s management made a SWOT analysis of their company. One of the weaknesses they acknowledged was a lack of “senior-level bandwidth to drive businesses”. One of the opportunities was institutional broking. The presentation pointed out that people with relationships were needed to “propel the business to the next orbit”. Few dreamt, however, that managing director Nirmal Jain would have the audacity to tempt the top brass of top foreign broker CLSA to his company.
The deal has made waves because of the amount of money offered to lure the CLSA foursome. The signing- on bonus is a hefty Rs44 crore, while they will receive 90 lakh warrants at the rate of Rs440 each. In terms of market regulator Sebi’s norms for the issue of warrants, at least 10% of these have to be paid at the time of allotment. So the Rs44 crore sign-on bonus goes towards paying this 10%. The arrangement is thus cash-neutral for the company, while it gets a big tax break from writing off the signing-on bonus amount to the P&L (profit & loss) account.
Also, with the stock having spurted by Rs157 in two days of trading after the news, the market capitalization has already gone up by more than the amount payable once the warrants are exercised. And if the new hires are successful and the firm prospers, the money can easily be recouped by offloading some of the equity to a foreign broker at a high price.
There’s little doubt that the ex-CLSA employees have a great track record and relationships built up over years. But big funds have a quarterly rating process for brokers and several criteria, including net worth on the basis of which they classify brokers, and business is then awarded on the basis of these rankings. The process of shifting large amounts of business is thus a slow one. And although some brokers believe that the smaller hedge funds and proprietary funds could shift, the market seems to be expecting too much.