L&T: Infra asset monetising could provide triggers

Given the debt-equity levels and need for funds in this segment, sale of equity stakes would help and improve the market sentiment

Even as Larsen & Toubro (L&T) is considered in a better position compared to peers, it is gradually losing its strong balance sheet advantage. There is rising debt at the consolidated level and a decline in productivity of capital, due to lower returns in some infrastructure projects.

As a result, its overall return on equity and capital has fallen in recent years. However, this could change if L&T’s plan to monetise some of its infra assets and selling stake in its infra asset-holding subsidiary materialises. If successful, it could provide triggers for the stock, also suffering due to the economic slowdown in India.

Standalone debt was Rs 8,834 crore or 0.3 times its equity, whereas consolidated debt was Rs 61,994 crore in FY13 (or 1.83 times the equity). Even after excluding the financial services business, the debt-equity ratio was high at 1.2 times.

Due to funding needs, the construction and infrastructure businesses have accumulated huge debt. Its infrastructure arm, L&T Infrastructure Development Projects (IDPL), which holds several assets, alone employs about 35 per cent of the consolidated capital. However, the contribution of these assets to overall revenues is minuscule, while they are currently incurring losses, proving a drag on L&T’s overall performance. Also, the infra business will need more equity and debt contributions towards existing projects, which together are expected to cost Rs 65,600 crore. All these are hurting the market sentiment.

“We lower our target price to book value multiple for development projects to 0.5 times from 1 earlier, due to continuing losses over the next two-three years,” said Bhavin Vithlani, who is tracking the company at Axis Capital. This is also a reason why L&T’s return on equity (RoE) on a consolidated basis is lower at 15.5 per cent compared to 17.3 per cent for the standalone entity. The standalone business, 37 per cent of total capital employed, contributed 94 per cent of consolidated profits.

Positive move
IDPL and other infra projects will require funds, both in terms of debt and equity, in future. With the return ratios subdued in this business, analysts believe limiting its (L&T’s) contribution or selling stake in some of these assets should prove positive.

“L&T’s management is of the view that since it has already invested substantial equity in IDPL and seen steady decline in RoE over the last few years, it would like to see IDPL fund its future requirement through internal generation or asset monetisation. L&T would want to limit further investment beyond the current commitment in its quest to improve parent’s RoE profile,” said Kunal Sheth, analyst at Prabhudas Lilladher.

IDPL has Rs 11,139 crore of debt (18 per cent of the consolidated level). The investment portfolio of IDPL consists of 21 major projects, including roads, ports and the Hyderabad metro rail. While Rs 6,000 crore of equity has been invested in IDPL so far, it will over the next five years require a further equity infusion of Rs 8,200 crore. Notably, the process has started wherein L&T is planning to fund these requirements through asset monetisation of the Dhamra port (in Odisha), the Hyderabad metro and sale of equity at the holding and SPV (special purpose vehicle) level. While speaking to analysts the company also indicated it could go for securitisation of future cash flows.

“The sharp rise in IDPL asset losses in FY13 (up four times on a year-on-year basis) could trigger long-pending asset divestment that L&T has been pursuing, thereby reducing the strain on overall cash flow and the balance sheet,” said Amit Mahawar, analyst, Edelweiss Securities.

Outlook
Though the prospects for the capital goods sector have not changed drastically, with L&T’s better positioning, reflected in its order book and good inflow of new orders, it will gain from a revival in economic growth and infra spending. Still, to combat domestic slowdown, it has increased the focus on global markets and this has already started yielding results. Export sales were up 68 per cent in the June quarter (27 per cent of total sales) to Rs 3,378 crore. For FY14, the company is expected to close with an order book of Rs 186,000 crore (up 21 per cent year-on-year), about 2.7 times its FY13 standalone revenue. In this light and given the historically low valuations, most analysts remain on about the stock.