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Larsen & Toubro has come under fire from analysts and investors after its first quarter results for FY15. The group’s chief financial officer, R Shankar Raman, explains the company’s point of view in an interview with Malini Bhupta. Edited excerpts:
Analysts are uncomfortable with the frequent changes in your financial reporting style.
We are not frequently changing the financial reporting format. Changes necessitated by business developments are inevitable. Subsidiarisation of the hydrocarbon business is supposedly being perceived as an effort to not disclose business information. This is an incorrect perception. The decision to hive off the hydrocarbon business as a subsidiary was not to mislead or hide information.
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The pros and cons of hydrocarbon as a standalone company versus as a division of the company were debated internally at length. When the process of subsidiarisation begins, it cannot be a part of the reporting of the standalone business. We have made disclosures in the quarterly reports of 2013-14, indicating hydrocarbon as discontinuing operations from a standalone results perspective. During the third quarter results for October–December 2013, we had disclosed the receipt of court approval for subsidiarisation of the hydrocarbon business and, hence, its exclusion from standalone numbers.
Likewise, when we commenced this year, 2014-15, we realised much of the business internationally was happening in the form of joint ventures outside of the parent company. If we stopped reporting these on a quarterly basis and reported only once a year, the market would not understand what was happening on a quarterly basis. We decided to close the books every 90 days and get the audit review to report those numbers. Also, the size of the universe around the parent company is becoming larger, which is why we wanted to report consolidated financial results on a quarterly basis while disclosing the details of standalone performance, as required under the regulations. We are surprised that this open approach is back-firing on us.
It is also believed that your guidance (forecast) is confusing and that you don’t adequately guide the market on changes.
At the start of the year, we give guidance on sales, order inflows and Ebitda (operating earnings) margins for the engineering and construction segments. And, whenever we believe there is a likely change, we inform the market. After all, if things have not gone as expected, we deem it important to reset investors’ expectations. It is not correct to say L&T does not communicate revision in the guidance.
What is happening in your hydrocarbon business?
In 2010-12, the orders we bid and won were approximately Rs 12,000 crore. Of these, roughly Rs 10,000 crore worth of contracts that we won in that period have got into trouble. As of March 2014, the executable international orders we had was Rs 5,000 crore in the hydrocarbon segment. In the first quarter of FY15, we have won another Rs 5,000 crore of hydrocarbon international orders. As of June 30, we have a hydrocarbon order backlog of around Rs 10,000 crore on an international order book of Rs 50,000 crore. The quality of the hydrocarbon order book is good as we see it now and the order book will, at best, have Rs 1,000 crore of orders which are remnants of the past.
Having assessed time and cost overruns as of June, we believe there is no requirement to make further cost provisions on these jobs.
What are the chances of clients reimbursing the cost overruns?
Though some clients have not entertained our claims fully at the handing over stage of the project, we intend not to give up these reimbursement claims. However, wherever the claim has not been accepted, we have to account for the cost overruns and also reverse the recognised revenues and the accrued margins, which is what we have done. As some of the decisions on reimbursements of cost overruns are taken only during the handing over of the projects, quantification of the final outcomes happens only at the conclusion of the project.
Some of these events happened in the first quarter of FY15 and we could not have forecast during the last quarter of FY14 that the client would not entertain the cost overrun claims. Technically, we could have staggered the provisioning due to continuing discussions with the client but we chose to take the hit upfront in the first quarter.
Would you say the company has been too aggressive in bidding for international orders?
It was more to do with under-assessment of risk, rather than quoting below cost. We believed our experience in India would give us the same ability to execute orders in the Gulf. We underestimated the risks significantly while bidding for some of these contracts, as we believed we had adequate expertise in the hydrocarbon domain, having executed several orders for Oil & Natural Gas Corporation in India.
As a company, our businesses are led by investments, and with India slowing, we believed we could grow by entering markets that we understood. While we were not chasing top-line growth, we went wrong in our underpricing of execution risks in these orders and that has gotten us into trouble. We are wiser now.
