India’s largest private sector engineering company Larsen and Toubro Ltd, or L&T, has ridden itself of the loss-making ready-mix concrete business at a decent valuation. The markets were evidently enthused— the firm’s market capitalization increased by Rs4,120 crore after the deal was announced, nearly three times the size of the deal (Rs1,480 crore).
The 5% rise in L&T’s stock price seems like a case of overreaction, but the market’s enthusiasm is at least partly understandable. While the firm’s net cash position would improve by Rs1,480 crore, the view seems to be that benefits from the sale of the business are greater since the unit’s losses eroded overall profitability. L&T doesn’t report the results of the division separately, but analysts are convinced that it generates losses. ACC Ltd, perhaps the only other large firm which has a presence in the ready-mix concrete business, reported a loss of Rs61 crore on revenues of Rs367 crore for the segment in the year ended December 2007. Besides, Lafarge SA’s statement that it expects its ready-mix concrete business to turn profitable in 2009 reveals that it has acquired a loss-making business.
L&T has said that the exit is in line with its strategy of focusing on core businesses and exiting others. While the segment also provided an input for its core engineering and construction business, it won’t be missed much because concrete mix can now simply be outsourced.
It’s difficult to make much of the valuation of the deal, since L&T hasn’t revealed financials of the division. An analyst with a domestic brokerage, nevertheless, points out that the valuation is good from L&T’s point of view, especially considering that it’s a loss-making business.
The L&T stock has corrected by about 35% from its highs in January and has underperformed the market by a large margin—the National Stock Exchange’s Nifty index has corrected by only 20% during the period. One of the reasons was the disclosure that one of the firm’s overseas arms would report hedging-related losses for the year till March. According to the firm, the losses would be offset by gains in the core operations since the cost of raw materials such as zinc would be lower. Some analysts, however, had assumed the overseas arm would continue to report the same level of profit as in the previous few years.
To make things worse, there’s been a slowdown in the capital goods sector, based on IIP (index of industrial production) data. At the same time, capital goods stocks such as L&T commanded high premiums because of the perception that growth would continue to be robust. This, coupled with the slowdown reflected in the IIP data and the possibility of execution risk highlighted by Bharat Heavy Electricals Ltd is the main reason for the stock’s underperformance. But even after the correction, the stock’s far from cheap, and if the slowdown starts getting reflected in the company’s financials, things could get worse.
India Infoline: more than just broking
Diversification of income streams has paid off handsomely for India Infoline Ltd in the March quarter. Despite the fall in volumes in the stock market, the company managed to show a 36% rise in earnings before interest, tax, depreciation and amortization (Ebitda) over the December quarter, although some of the shine was taken off that performance by a sharp rise in interest costs. The upshot: A fall of 9% in profits before tax compared with the December quarter, not bad at all when viewed in the light of the hurricane that passed through the capital markets during the March quarter.
Income from broking was lower by 11% or Rs22.9 crore compared with the previous quarter, but that was more than compensated by an increase of Rs74 crore in the financing business. Moreover, in spite of a 29% fall in broking volumes, the fall in revenues was limited to a commendable 11%—analysts say this is on account of higher institutional business. The company’s financing revenues totalled Rs111.4 crore in the March quarter, while revenues from equities broking stood at Rs192.2 crore. Within the financing segment, the margin-funding book amounted to Rs660 crore, while the consumer finance portfolio, three-fourths of which were mortgages, amounted to Rs329 crore. However, the life insurance commission business, touted as a source of diversification, didn’t live up to expectations, falling 14% compared with the previous quarter, probably because the preponderance of unit-linked schemes directly connect the performance of this segment to conditions in the stock market. Merchant banking income also showed a substantial increase.
While the expansion of consumer finance will help de-risk the company’s business, this is a segment in which many big players have burnt their fingers and notched up bad debts.
Perhaps it’s for this reason that, in spite of the diversification, the stock has more than halved from its 52-week high, more or less in line with other broking stocks.
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