L&T shares have returned just 1% over a year as macroeconomic concerns and the non-core acquisition of Mindtree weigh on investor sentiment.  (Naveen Kumar Saini/Mint)
L&T shares have returned just 1% over a year as macroeconomic concerns and the non-core acquisition of Mindtree weigh on investor sentiment. (Naveen Kumar Saini/Mint)

With L&T's return ratios under pressure, investor returns are hit too

  • Investors have perceived L&T's decision to buy Mindtree as negative in the near term as its pushing cash into a non-core business
  • A failed share buyback offer earlier this year is also weighing on L&T shares, down about 5% so far in 2019

Mumbai: Larsen and Toubro Ltd’s (L&T’s) shares are down about 5% this year, even as the Nifty 50 index has risen by over 8%. The fall in L&T’s shares come despite the positive news on order flows and improving fundamentals in its core business. Worse, its one-year forward price-to-earnings multiple of 19 times is way below the levels of 24 times a year ago as well as the five-year average of 23 times earnings.

The first dampener for the stock came early this year when the Securities and Exchange Board of India (Sebi) rejected its share buyback offer, which was meant to return excess cash and boost return ratios. Investors have also perceived the decision to acquire software firm Mindtree Ltd as a negative in the near term because of a worry about using cash in non-core businesses. Some analysts also said it can weigh on near-term return on equity (RoE) of the company.

“Investors are not happy with L&T’s capital allocation to MindTree, especially in context of RoE being sub-5% at the acquired valuation multiple (of about 20 times)," said Jefferies India Pvt. Ltd.

L&T has set a target of achieving 18% RoE by FY21, which is now under question, given the Mindtree deal and the rejection of the buyback offer.

Growth prospects have also turned grim both in India and globally. Private sector investment is showing no sign of improvements. The slow pace of earnings growth in the core sector and poor capacity utilization may thwart private sector capex for some more quarters.

The overhang of the general elections will also limit government capex until the second half of FY20. “We do not expect the strong 15% CAGR seen in FY08-FY13 to repeat, especially as power will not be a major capex driver ahead. However, from negative growth, we expect to move to 10%+ CAGR over the next four years," said Jefferies India.

However, L&T’s efforts to contain working capital should bring down interest cost as a percent of sales. Meanwhile, the March quarter is usually robust on execution, translating into better conversion of orders into revenues. Also, analysts say L&T’s order flows for FY19 will top its guidance of 10-12% growth over a year ago. Investors will hope that improved fundamentals in the company’s core business will offset the negative investor sentiment due to recent developments.

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