Analysts see Rs 140-billion L&T-Schneider deal in positive light

Brokerages, which had estimated the electrical and automation business to fetch Rs 140-160 billion, say valuations are fair

Larsen & Toubro’s (L&T) definitive agreement with Schneider to sell its electrical and automation (E&A) business in an all-cash deal for Rs 140 billion (slightly more than $2 billion) is on expected lines of analysts.
 
Santosh Yellappu, analyst at India Nivesh, says, the deal valuations are fair and the company is pursuing its objective of becoming asset-light. Earlier Credit Suisse, too, had anticipated the electrical business’ value at ₹140-160 billion.
 
The business had reported net revenue of Rs 50.38 billion (about five per cent of overall) during FY2016-17, with Ebitda margins of about 15 per cent. Thus, the deal is happening at about 2.8 times the E&A business’ revenues and at 6.6x its Ebitda.
 
Morgan Stanley says, the valuation works out to 17x enterprise value (EV)/EBITDA and 31x earnings for FY19. “L&T stock trades at 24x estimated EPS for FY19 based on consensus earnings. We view the deal positively from a sentiment perspective as it reiterates L&T's resolve in unlocking value while continuing to dominate EPC space,” it said.
 
Credit Suisse, too, shares a similar view. “(Sale is) strategically positive as the business is non-core with technology risk. Cash usage would be key. Valuation is value neutral versus our target price.”

 
However, there could be an interim impact. Since profit margins in E&A business are higher than L&T’s Ebitda margins (excluding services) of 9-10 per cent, the sale is likely to have some bearing on the consolidated number, post completion of the deal. However, the impact will be curtailed by its small revenue contribution of less than five per cent.
 
On the use of sales proceeds, analysts say, L&T can utilise it to strengthen its balance sheet by repaying some of the debt, similar to its moves to reduce its net working capital (NWC). The company is expected to close FY18 with a debt-equity ratio of 0.8 (debt of about Rs 1 trillion), estimates Motilal Oswal Securities. While L&T’s NWC declined from 25 per cent at end-FY16 to 22 per cent in Q3’FY18, it intends to bring down further to 18 per cent of sales by FY21, say analysts. Additionally, it can deploy some of it to capture opportunities thrown up by higher economic growth.
 
G Chokkalingam, founder and managing director, Equinomics Research and Advisory, says, the divestment will accrue positives and will lead to significant cash flows at a time when economy is expected to pick up and will drive L&T’s growth to the next level too.
 
Even before this deal, analysts were positive on L&T due to its improving order execution and order flows. Edelweiss, for instance, expects a gradual, but broader recovery in domestic market for L&T during the March 2018 quarter, as was seen in Q3FY18 and the first nine-months of FY18 which saw core infrastructure execution growth of 20 per cent and 15 per cent, respectively. Execution in the domestic engineering and construction (E&C) segment has also picked up post GST (goods and services tax) implementation in 3QFY18 and analysts at Motilal Oswal expect the momentum to continue in March quarter. They project order inflow of Rs 462 billion (flat year-on-year) in Q4’FY18, but build in a 5, 10 and 14 per cent growth in L&T's order inflows for FY18, FY19 and FY20, respectively.
 
The L&T’s stock has been on an uptrend, outperforming the Sensex since December last year. Currently, at Rs 1,400.60, it is not far from its all-time high of Rs 1,469.60 seen in early February.