Reinventing L&T for growth

The moves to restructure its businesses and separately list subsidiaries should help L&T achieve its goal of growing fourfold over the next decade.

India's engineering and construction giant, Larsen & Toubro (L&T), has kick-started the process to move to the next level of growth. The company aims to grow fourfold in size over the next decade. While this implies a compounded annual growth rate (CAGR) of over 16 per cent, given L&T's current size it is reasonably good and not far from the 22 per cent CAGR in consolidated revenues recorded in the last eight years.

To meet this goal and ride on India's economic growth, the company has chartered several plans including the recently announced organisational restructuring initiative. The latter will see L&T's large portfolio of businesses split into nine separate independent companies with their own management teams. Though this exercise will yield returns in the longer run, the markets seem to have given it the thumbs up. L&T's stock closed 0.42 per cent higher at Rs 1,669.60 on Tuesday against a nearly one per cent decline in the BSE Sensex.
 

IMPRESSIVE SHOW
	CAGR (%)  (FY02-10)
Net sales	22.4
PBIDT	26.8
Adjusted PAT *	38.3
Market capitalisation	47.0
Financials are on consolidated basis * excluding exceptional/extra-ordinary items Source: CapitaLine Plus

"The move is good. At least they are taking the first step to do away with the conglomerate structure. Generally, a large conglomerate gets less value (by the markets) until the businesses are spun off or listed separately," says Chetan Parikh, director, Jeetay Investments Private Limited.

How will shareholders benefit?

"As a result of restructuring and listing of its subsidiaries -- whose value does not get fully reflected in L&T's valuations -- there is potential for value unlocking. Additionally, a separate management and board will have an impact on the overall performance (improve growth rates) of the company as a result of higher responsibility and a focused approach," says Gaurav Dua, head of research, Sharekhan.

Fourfold growth over the next decade at the current profit margins translates into revenues of Rs 1,75,000 crore and a net profit of Rs 15,400 crore as against consolidated net sales of Rs 43,837 crore and a net profit of Rs 3,845 crore in 2009-10. If similar growth is assumed in its stock valuations, L&T's share price would reach around Rs 6,600 by end-2020.

Unlocking value

Restructuring apart, the company plans to gradually list some of the newly carved businesses along with its large subsidiaries like L&T Finance, L&T IDPL, L&T Infotech and L&T Power. Many of these businesses are operating in high-growth areas and will need capital to sustain growth in the coming years. L&T's management believes it will be easier for it to manage growth if they operate as separate entities.

Meanwhile, most of these fast-growing subsidiaries are today conservatively valued by analysts (usually at a discount to their peers). Among examples: L&T Finance, whose asset base and net profit have grown at an annual rate of 77 per cent and 62 per cent in the past five years through March 2010 to Rs 11,491 crore and Rs 267 crore respectively, too has large opportunities in the financial sector.

Likewise, L&T Power recently commissioned its power equipment manufacturing capacity of 5,000 mw. On the back of an order book of 10,000 mw or Rs 32,000 crore, the company is looking at achieving annual revenues of $3 billion (Rs 13,500 crore) in four years, which is almost 30 per cent of L&T's current consolidated revenues. Similarly, L&T IDPL, which has 37 projects worth Rs 33,500-40,000 crore spread across sectors like roads, ports, railways and real estate, has huge growth potential.