India may be an 8-month market in FY25 due to polls, efforts to improve margins will continue: L&T CFO

R Shankar Raman, President and CFO, L&T

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Engineering major Larsen & Toubro's shares have been trading in the red for two consecutive sessions, ever since the company announced its FY24 results. While the company reported robust profits, revenues, and order growth, its guidance on margins had investors concerned.

The company’s President and Chief Financial Officer (CFO), R Shankar Raman, spoke exclusively to Moneycontrol, explaining why he thinks investors should not be worried.

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Raman expects lower order inflows till September 2024, and a scattered workforce due to the elections, but said that the company will do its best to ensure execution is not impacted as that is critical for cash flows.

He also spoke on the outlook for the Middle East market, the company’s divestment plans, and the road ahead.

Edited excerpts:

You have given an EBITDA margin outlook of 8.25 percent for FY25, and this hasn't gone down well with the market. L&T shares are in the red for a second consecutive session. What would you say to that?

In FY24, our profit after tax (PAT) grew 25 percent on the back of 21 percent growth in revenues and 30 percent growth in orders. Which actually makes ours a solid, well-rounded performance. But it is also a fact that while the overall margin has been 10.6 percent, the projects and manufacturing business has reported a margin of 8.2 percent. This 8.2 percent is what has been receiving a lot of attention over the last two days. And it was in the context of 8.6 percent the previous year that the 8.2 percent has caused some flutter.

But let me try to give you and the investors some context. Margins are one side of the coin. The other side is the resources we deploy to earn that profit. When we had an 8.6 percent margin in our projects and manufacturing business, our working capital intensity was much higher, almost 18 percent of revenues.

When we are reporting 8.2 percent for FY24, the working capital intensity is 12 percent, which is a sharp decline. What has gone unnoticed is the level of resources the company has deployed to earn the profits it has. This focus on one element of value-creation to the exclusion of others often creates the disappointment that we are seeing. And it is our duty to correct that perspective.

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Secondly, I think it is also equally important to understand that in the projects vertical, our business mix is undergoing dramatic change. Earlier, 20-22 percent of the projects were from international markets; now that accounts for 40 percent of the order book — this has implications.

One of the reasons why capital intensity has improved is that international projects have better cash flow during execution, compared to Indian projects. In Indian projects, the cash flows are back-ended. In international projects, the cash flows are evenly spread or sometimes front-ended.

Given this, the time value of money comes into play when it comes to bid evaluation. We obviously will charge differently if you are going to receive money 1-4 years down the line compared to receiving money on day one. If you adjust for the time value of profits, then margins of 8.6 to 8.2 percent will not look like a deflator, but actually look better than the 8.6 percent that we reported last year.

Having said that, we are not saying that efforts to improve the margins from 8.2 percent have ceased. We will do everything possible to make sure that we operate more efficiently and profitably.

At a time when a 40 basis-point-dip in margin is getting commented about, we also need to see that return on equity (ROE) has improved by 270 basis points (bps) to 15 percent. ROCE (return on capital employed) is up 200 bps. So, when you look at profitability in a holistic manner, there is not so much to worry about.

Q. You have given a 10 percent order growth guidance for FY25. Analysts expect that orders inflows from the Middle East will fall in the fiscal, which will put pressure on you to have a better win rate in India. What’s the pipeline looking like and what’s the win rate you are targeting?

This is a good question because it does reflect the current realities and trends. Our prospect pipeline comes close to Rs 12 lakh crore. Of this, 60 percent is in the domestic market and 40 percent in the international market. In the domestic market, I think we are betting on a continuity of the investment policy, continuity of the growth model we have been following for the last three-four years.

Today, the Middle East is investing anywhere between $60 to $100 billion a year across various programmes. Saudi Arabia alone is investing about 60 percent of this. I gather the country will moderate its investment in hydrocarbons, and divert resources for a more broad-based infrastructure development. At $80+ per barrel, it looks like oil prices will remain stable and generate enough profits for the Middle Eastern oil and gas companies and governments, which have been the largest investors.

The money that is generated through this is apparently getting diverted to areas like solar energy. You may be aware that L&T alone is executing 18 gigawatts of solar power projects in the Middle East. It is a huge footprint, and solar power has tremendous potential. I think that momentum will continue, the tailwinds will continue in terms of more and more power getting generated.

The Middle East also wants to grow as an economy. It is developing new cities, it is connecting itself through railways, it is improving its port connectivity, etc. Given all this development, I think it is inevitable that they would need energy and they are not going to go overboard on hydrocarbons as they used to. I think they will balance it out a bit.

Responsible investing takes reallocation into account, and that is what is happening in the Middle East. At the height of Covid, we were still working and delivering projects. Very few companies did that, a lot of companies actually scooted. This has made our reputation formidable there, and with every success, the clients appreciate that here is a company which can be partnered with on a long-term basis rather than engaged from contract-to-contract. So we are pretty optimistic.

There will be interruptions like the elections, etc. India will possibly be an 8-month market in FY25. By the time everything settles down and new orders start coming, it could be July or even August. That is something we will have to take it in our stride and see how we can make up. This is why we have a 10 percent growth guidance on order inflows, on a very large base of Rs 3 lakh crore.

Q. The power equipment business has been a tough one for L&T, given the environment in the sector. Now, in order to encourage competition, the Central Electricity Authority (CEA) has relaxed the pre-qualification requirements, which will allow companies with experience in 'sub-critical' units to participate in 'supercritical' projects. Will this be a negative for companies like L&T, who enjoy a strong presence in this space?

If you want more players to compete, relaxing pre-qualification requirements is not the right route. It will drop standards. I think it is important to tighten pre-qualification terms so that those who participate do so with reasonable confidence that the project will be successfully completed on time and within cost.

Secondly, I think it is important to attract more people. The terms of trade have to be made more conducive. In the power sector, the tendency is to withhold retentions and guarantees until the project is done, which may take four-five years. The banking resources of the country will get stretched if monies are blocked beyond such retention and guarantee periods. Rather than dropping the threshold, the sector should make the terms of engagement more attractive so that more people come forward.

Q. How do you think the Reserve Bank of India's (RBI's) draft proposing tighter norms for lending and heightened monitoring for under-construction infrastructure projects will impact project costs in India?

While a larger provisioning might seem harsh, I think it ensures better selection. We should never forget that India is a resource-scarce nation. We might be doing well economically, but as a nation, we still have more needs and wants than resources available.

So, it's very responsible of the RBI to ensure that lenders, the financial institutions do due diligence when deciding which projects to lend to. We have had numerous instances of projects being awarded to less-than-capable contractors, which were never completed. Even if they are completed, they are completed with cost and time overruns, which lock in more of the bank's resources. RBI has given the right signal by telling lenders to back projects which can be completed within cost and time.

But the short-term effect of that could be some rationing of resources. I think it augurs well on a broader scale, and maybe over a year or two, this will settle down. India needs good projects, projects which will add value to its economy. And this move, in my opinion, will support that.

Q. L&T has been gradually exiting non-core businesses. What’s the plan for FY25 on that front?

We have done almost all the divestment per our FY21-FY26 strategy plan. The only two non-core businesses that feature in our portfolio are Hyderabad Metro and Nabha Power. Of these, Nabha Power is in a better place because it is operating at about 85 percent PLF (plant load factor), generating close to Rs 4,000 crore in revenues every year, and about Rs 400 crore of profits. It is a monetisable asset. We will wait and watch how this goes.

As for Hyderabad Metro, there are a few things we need to fix before the asset becomes monetisable. I think we will get those fixed in FY25-26, and maybe in the strategy plan of FY26-31, we will see the divestment of Hyderabad Metro.

Q. This is an election year and a lot of what you are doing is very closely tied to how the government operates. What would be the one big challenge for this financial year?

The workforce has been scattered somewhat because much of the project work is done by migrant workers. Because of the elections, most of them are returning to their villages to cast their vote. This is a bit of a disruption, because you have to disassemble the skills, and then reassemble the skills. But regardless, our completion timelines don't change. I think the efficiency with which we get the workforce back — of the right mix, and of the right quality — is something that's going to be key.

We hope there is continuity of economic policies, as we have benefited a lot from that over the last three, four years. Whichever dispensation the people choose, I hope that the wisdom of the growth-first, investment-led approach sustains.