Services segment's contribution powers L&T to change business mix

Larsen & Toubro (L&T), an engineering major perceived as a proxy to core sector economic activity, is seeing its services portfolio getting strengthened. A closer look at the company’s financial performance in the June quarter reveals it is coming out of its traditional image.

Contribution from the services sector to L&T’s order inflow in April-June 2018 was an impressive 21.8 per cent, second to infrastructure that continued to be high at 42.9 per cent.

L&T’s order inflow for construction and infrastructure during the June quarter grew 35 per cent year on year, but the number jumped to 37 per cent when combined with contribution from services sector.

“Even though L&T has placed itself as a flagship construction or engineering company, from an investment point of view we have seen it as a conglomerate, valuing it on its different businesses,” said Sanjeev Zarbade, vice-president-PCG Research at Kotak Securities.

In the April-June 2018 quarter, the services sector contributed close to half of the group’s segment earnings before interest, taxation, depreciation and amortisation or Ebitda and about 27.9% to its total revenue.

In the last financial year, the company’s total order inflow growth was higher, compared to what it would have been excluding services sector. The segment’s contribution to total revenue was at 17.7%, second only to infrastructure.

The services sector is seen as a segment that allows L&T more legroom to improve margins. “They are continuing to hold their services business well, which has helped the company’s performance in this quarter. The capital allocation issues that people had, core construction is not materially changing or improving, the margin and revenue growth continues to be range-bound,” said Nitin Bhasin, head of research at Ambit Capital.

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The infrastructure and construction business due to macro concerns like government policies, clearances and other delays offers limited headroom for margin expansion. “IT and banking and financial services were seen as non-core (for the company), but that may be changing. The company may focus on IT and banking more, while the construction business (group excluding services and asset ownership) continues to remain the big pie,” Bhasin said.

L&T’s multiple business divisions have seen noticeable changes in the last one year. The electrical and automation business will be carved out once the sale of this division to Schneider is complete. In addition, L&T has reclassified from the June quarter its metallurgical and metal handling (MMH) business under the infrastructure vertical, from its previous classification under ‘others’ segment.

The company’s defence business has been carved out from heavy engineering vertical and reclassified as defence engineering.

Renu Baid, analyst at IIFL, sees this as reflective of the changing nature of orders. “MMH under infrastructure (segment) does not change the infrastructure in a big way or make a big swing, though it is a margin positive segment. The profile of orders is also changing, where orders are coming on a complete engineering, procurement and construction business,” she said.

More changes could be in the offing with L&T likely to reduce shareholding in the IT-listed entities to meet market regulations. “In the next 12 to 15 months, L&T will bring down its share in Infotech and Technology Services to 75% level, leading to value unlocking and improved cash flows,” Baid said. However, others like Bhasin are confident the services sector will remain a significant business despite the regulatory requirements.