Ongoing divestment, healthy order inflows positive for Larsen & Toubro

Analysts expect a 12-15 per cent upside from current levels

Larsen & Toubro (L&T) has entered into an agreement to sell its stake in L&T IDPL (Infrastructure Development Projects) and its subsidiaries to EPIC Concesiones, a special purpose vehicle (SPV) created for the transaction. The SPV is held by the Infrastructure Yield Plus II, an infra fund managed by Edelweiss Alternative Asset Advisors. The total consideration is Rs 6,000 crore.

This is a part of L&T’s strategic plan of divesting non-core businesses, given limited growth opportunities. It has already exited general insurance, Katuppali Port and E&A business. In the next stage, L&T plans to divest its stake in Nabha Power and Hyderabad Metro.

The successful completion of the IDPL deal will be followed by the Nabha Power divestment, which will help scale down debt by Rs 5,300 crore. The target is to reduce consolidated debt to Rs 23,000 crore from the current level of Rs 40,000 crore.

Over the years, L&T has developed a well-diversified business model and it is the engineering, procurement and construction partner of choice in India. The divestments strengthen the balance sheet going into the next leg of the investment cycle.

L&T (51 per cent stake) and the Canadian Pension fund CPPIB (49 per cent stake), have entered into an agreement to sell the entire stake in L&T IDPL along with its subsidiaries (11 road assets, and one transmission line asset) to EPIC Concesiones for an equity value of Rs 2,720 crore suggesting L&T will realise equity value of Rs  1,390 crore for its 51 per cent stake.

L&T's carrying value of equity investment in IDPL stands at Rs 1,100 crore and this deal is thus valued at 1.3 times book value. The actual equity investment in IDPL stands at Rs 2,800 crore with registered impaired investment of Rs 1,720 crore.

In the meantime, the core business has seen strong performance through the first half of the 2022-23 financial year ((H1FY23) as well as robust order inflows. The H1FY23 has seen core revenue up 24 per cent year–on-year (YoY) while order inflow grew at 44 per cent YoY to Rs 93,700 crore. L&T has scaled up its guidance on the revenue front for FY23 to the upper end of 12-15 per cent YoY growth. The overall order pipeline stands at Rs 6.3 trillion, including domestic orders of Rs 5.0 trillion and Rs 1.3 trillion overseas.

However, the core margins have been under pressure and L&T has toned down margin improvement guidance by 30 basis points YoY to 9.5 per cent margin in manufacturing and projects division for FY23. The H1FY23 core margin stands at 7.3 per cent vs 7.5 per cent in H1FY22.  Margin improvement will be a crucial metric going forward.

There’s potential for higher growth with better margins in digital solutions and automation. L&T plans to leverage this opportunity through its IT companies like LTTS (automation, IoT in manufacturing, hi-tech, and industrial products), LTI (data analytics, AI in retail, media, and BFSI segment), and L&T NXT (AI, IoT, augmented reality, cyber security).

L&T has organised revenue streams under three segments: EPC Projects, HiTech Manufacturing and Services. Investments include Rs 1,100-Rs 1,200 crore in setting up 1 GW (gigawatt) electrolyzer plant by 2028, and incremental investment of Rs 3,100 crore in setting up advanced chemistry cell manufacturing plant of 5 GW in a JV with a partner and a 3 GW battery module manufacturing plant.

The services segment is expected to grow in the high-teens and this will also hold a data centre business with a 90 MW data centre by 2026. The impact on the share price of the news is marginally positive. But analysts see a fair upside of 12-15 per cent for the stock.