The tectonic shift unfolding at Larsen & Toubro

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

Larsen and Toubro is a sprawling conglomerate. It operates in and reports quarterly performance figures for nine separate segments—infrastructure, heavy engineering, power (building thermal plants), defence (including aerospace and shipbuilding), hydrocarbon, concession-based development projects (metros, roads, etc.), information and technology (consisting of the separately listed businesses L&T Infotech, L&T Technology Services and Mindtree), financial services and a miscellaneous grouping of everything else under “others" (real estate, industrial products, smart city projects, etc). Most of these businesses operate in about 30 countries besides Indi

Given this complexity, the L&T machine operates much like how India used to under its erstwhile planning commission. It has periodic 7-10 year long-term “perspective" plans that are divided into shorter strategic five-year plans, titled ‘Lakshya’, which are then further broken down into annual targets.

The most recent Lakshya FY16-21, which aimed to double sales while improving margins and divesting non-core assets, coincided with the transfer of management control from group chairman AM Naik to his protégé and the current chief executive SN Subrahmanyan. Trained as a civil engineer, SNS (as he’s referred to both within and outside L&T) rose through the ranks as an infrastructure and construction specialist. As CEO, however, he has had to steer an infra company through a sustained collapse in funding from its primary client—Union and state governments.

The central planning structure has shaped L&T’s history in the last few decades, allowing it to stay ahead of the game by presciently moving into new business verticals (such as its emphasis on IT in the aughts) and moving out of infra asset ownership over the past few years once such structures turned toxic.

While covid has delayed the new Lakshya announcement, the company’s recent performance metrics and a slew of new investments are an indication of what SNS is thinking: That the bulk of L&T’s growth prospects may lie outside its traditional infrastructure paradigm.

IT outshines infra

L &T’s revenues from its traditional strongholds—infrastructure, hydrocarbons, power, defence, development projects—have plateaued over the last five years, as have their profit margins. In contrast, the revenue from its three key IT subsidiaries is contributing to a larger share of the consolidated topline, especially after the acquisition of Mindtree.

“The target is... to grow the share of the IT businesses from the current 20% in the overall revenue mix," SNS told Mint.

The divergence in performance is starker when one looks at the pre-tax profit break-up; the IT and technology subsidiaries accounted for over 45% of the profit in the first half of FY22, growing from 33% at the close of the last fiscal. Infrastructure’s contribution over the same period shrunk from just over 31% last fiscal to under 24% in the first half of FY22.

“L&T is increasingly becoming a services, and not just an infrastructure, company," Abhishek Shukla, associate director, India Ratings and Research, said. “Even if they are not de-emphasising infra as a segment, the fact that the IT subsidiaries account for a large chunk 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 against the background of the company’s steady sale of “non-core" assets over the Lakshya FY16-21 period, some of which contributed to the services division.

These divestments included the sale of L&T’s general insurance arm to HDFC Ergo and the Seawoods Grand Central Mall in Navi Mumbai to Blackstone Group LP in 2016. The single largest divestment over this period was the all-cash sale of its electrical and automation division to Schneider Electric for ₹14,000 crore last year. More recently, in August, it sold its 99-megawatt hydroelectric power plant in Uttarakhand to ReNew Power for ₹985 crore.

L&T set up the Infrastructure Development Projects Ltd (IDPL) division in 1995 to house the parent company’s portfolio of build-operate-transfer (BOT) assets and public-private partnership projects, including highways, bridges, sea ports, transmission lines, wind energy and metro rail projects. Many of these projects are now held as part of the infrastructure investment fund IndInfravit or have been sold. Since 2014, the Canada Pension Plan Investment Board has acquired a 49% stake in IDPL, which now primarily holds road projects and power transmission lines, while L&T hopes to fully exit this venture by 2023 and, with it, much of its development interests.

The two large assets that L&T has had a tougher time selling in the market is the 1400-megawatt ₹9,000 crore Nabha thermal power project in Punjab and the loss-making Hyderabad metro rail project (L&T’s single largest project investment of ₹ 18,000 crore). The Nabha sale is hamstrung by a glut of thermal power plants in the market after the cleansing of bad loans by banks post 2017 and a reluctance by overseas funds to buy into coal power due to carbon-neutrality goals.

Phase one of the Hyderabad metro line became fully operational in February 2020, just a month before the country went into a strict covid lockdown. The metro rail subsidiary reported a loss of ₹1,767 crore in FY21.

However, things are starting to look up this fiscal. In Q1 FY22, L&T reported that average metro ridership was around 55,000 passengers a day; this figure quadrupled by October, with a daily average of 190,000 to 200,000 passengers a day. In the second quarter earnings call with stock market analysts, P Ramakrishnan, Head, Investor Relations, L&T, said the company is evaluating a range of options to make the project sustainable. Its 60-year concession period will also, hopefully, make it an attractive prospect for investors.

Few local takers for NMP

L &T’s sustained attempts to turn its balance sheet asset-light is nearing its end ironically at a time when the government wants the private sector to expand its ownership of infrastructure assets.

Through the national monetisation pipeline (NMP), the government hopes to raise ₹6 trillion by 2025 by selling a host of publicly-owned assets. L&T’s activity within the infrastructure space is often seen as a proxy for the broader market; it’s decision to continue to remain asset-light, avoid locking up capital in long-term concessions and move towards a new services direction doesn’t augur well for the government’s plans.

“With the experience infrastructure companies have gained over the last two decades, we now know that there’s a definite risk associated with the ownership of assets. (These range from) getting traffic assumptions wrong and having judicial orders go against you to having a power purchase agreement forcibly renegotiated," Shukla of India Ratings said. “Historically, we used to assume that real estate companies (would) want to accumulate land banks and that infra companies (would) want to own assets. We’re seeing the opposite happen now; the lean balance sheet has become woke."

“I believe that overall, the infrastructure sector is moving in a direction where assets will be held by long-term financial investors such as private equity or sovereign wealth funds," Shukla said. “In asset ownership, a company brings (in) its competitive advantage by accurately predicting the number of (future) users and by accessing cheap capital. You don’t really need the technical expertise of construction in-house."

“If you take a 3–5-year view of the Indian economy, wherein, private and public capital expenditure is bound to pick up, then L&T is your best play," Nilesh Bhaiya, equity research analyst, Motilal Oswal Financial Services, said. “L&T is now a pure EPC (engineering, procurement, construction) play, with no BOT, no hybrid annuity on roads, etc. So, as the macro economy starts to do better, L&T’s core business will pick up too."

“Meanwhile, the IT subsidiaries have held the ship steady for L&T even pre-covid when capital expenditure had slowed down. The core business is valued at a price-to-earnings multiple of about 13 times; the IT subsidiaries at roughly 40 times," Bhaiya said. “Look at L&T’s peers from a decade ago—Punj Lloyd, Supreme Infra, HCC, GMR, GVK, Jaypee, Lanco Infra, Gammon, and so many more are now struggling to survive. So, even as the company tilts more and more toward IT and services, for an investor, it’s still a good infra bet."

A new direction

Once Nabha power and Hyderabad metro are off its books, L&T will become more or less debt-free for a company of its scale (excluding about ₹90,000 crore of debt on account of the lending arm, L&T Finance). Today, it holds about ₹26,000 crore in surplus cash and by all indication, Lakshya 22-27’s investments will go deeper into the services territory.

In October came the launch of L&T EduTech, which group chairman AM Naik said will train engineers with the “storehouse of knowledge and expertise (L&T has) gained from having executed some of the most complex and demanding projects over past decades." Sufin, an e-commerce platform meant to ease supply chain and finance management for small and medium businesses, is expected to go live later this fiscal.

Given L&T’s water neutrality (2035) and carbon neutrality (2040) targets, engineering and services aimed at an energy transition will gain prominence in the new plan, company watchers believe.

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 also intend to consider partnerships with renewable power companies to offer services on the green hydrogen front."

A senior Mumbai-based infrastructure analyst told Mint on condition of anonymity that the infrastructure capex cycle is unlikely to recover in a hurry. “I think this is part of the reason why they (L&T) have decided to go all-in on tech. Even until two years ago, IT and tech were a me-too offering from the L&T stable. The hostile takeover of Mindtree in 2019 is part of this new aggression and now, about 50% of the current stock value is based on the IT subsidiaries," the analyst said.

“The market already views L&T as an IT play, in addition to an infra play," he said. “L&T itself clearly sees its future in technology and finance, and I think to that extent, it’s legacy as an infra company will change."