MC Interview | Order win rate 20 percent so far in FY24, infra margins will improve: L&T CFO  

Engineering major Larsen & Toubro’s (L&T) order win rate has been 20 percent so far in fiscal 2023-24 but the company is closely watching its pipeline for any possible slowing in the domestic ordering process due to upcoming state and Union elections, chief financial officer R Shankar Raman told Moneycontrol in an exclusive interview.

L&T reported strong growth in revenue, order inflow and profit after tax growth in Q1FY24. But its biggest business, infrastructure projects, witnessed a contraction in operating margins, weighed by some legacy orders that carried low input costs prevailing at the time. Raman said that the impact of these orders may last till the December quarter, after which the order mix should support margin growth.

In a freewheeling interview, the CFO shared the outlook on the different businesses of the company, prospects of big-ticket orders in West Asia, and L&T’s farewell gift to chairman AM Naik, who steps down in September. Edited excerpts:

L&T has announced that it will buy back as much as Rs 10,000 crore worth of shares at a maximum price of Rs 3,000 apiece. The last time you attempted it, the Securities and Exchange Board of India (SEBI) had rejected it because of debt concerns as the consolidated number included debt on L&T Finance’s books. How is it different this time? 

Since the last time, we have obtained a lot of regulatory clarifications. Last time, the Companies Act was talking about the entity which is going to do the buyback, whereas SEBI looked at it as a group. And financial services is part and parcel of our group and that is a debt-heavy business. So the debt of financial services was aggregated at SEBI's headquarters, whereas the Companies Act excluded them. So there was a bit of confusion on what defines the debt-equity post-buyback. But since then, we've worked with SEBI and SEBI had subsequently issued clarifications and guidelines, which now make it very clear. And another big change is while making all these changes, SEBI also said that so long as the regulations are met, and they are certified by an appropriate agency, SEBI just needs to be kept informed. There is no approval that is required from SEBI. So to that extent, the process has become simpler and more predictable.

What’s the rationale behind the share buyback and the timing?

It has got nothing to do with a timeline or share price, let me clarify. I think part of the Lakshya FY26 plan (L&T’s latest and ongoing five-year strategic plan) and the strategic plan that we drew between FY21 and FY26 had ROE (return on equity) improvement as a key target. The  ROE improves because of two things. One is the businesses being run more profitably than in the past. And secondly, the capital intensity in the balance sheet reduces. So a combination of return-accretive business and divestment of capital-heavy items in the balance sheet could actually lead to this ROE improvement. We have, over the last two years, been working on both. We are trying to improve the profitability of the businesses. At the same time, we are also trying to get out of businesses that are capital heavy and, hence, not necessarily return-accretive in the short to medium term. Added to this is also the focus on cash flow management within the organisation. Today, I think every project site and every project director is conscious of the fact that the work done has to be reimbursed by the client in a quick time. So the cash-to-cash cycle has received a lot of focus. That has brought down the working capital intensity in the company's operations from over 25-26 percent of revenue. Today we are running at about 16-17 percent of revenue.

The capital unlocked in this process and the non-allocation of further capital to asset-heavy operations have resulted in a cash surplus. Our job as a public limited company is to work for shareholders' value creation, and shareholder value creation happens both through capital appreciation of the stock price as well as the yield of holding that investment going up. One way the yield can go up is through dividends, which we have kept up. The dividend payout ratios are today upwards of 40 percent. They used to be 20-25 percent a few years ago. And secondly, I think once we assess the requirements of cash for all our requirements for the next few years if the cash available is more than what we require, we think it is appropriate to return that cash to the shareholders.

We're extremely confident that if the company requires capital, it should be able to go to the market and raise it as and when required. But in any case, that doesn't seem to be the course for the next few years. That being the case, we thought that it is as good a time as any to do this. Also, I think it is an important transition that's happening in the company. Our chairman, Mr Naik, after such a long and glorious innings, is stepping down. His term comes to an end on September 30. And he has always been a well-wisher of shareholders in terms of his thought process and actions. So we thought it'll be also fitting that when he steps down, the shareholders have something to rejoice about, both in terms of the special dividend that we're giving at Rs 6 per share, as well as this buyback offer.

The infra projects business had a robust performance in Q1FY24 but margins declined due to legacy orders. Are there more such orders? What sectors are driving the growth and what’s the outlook on margin?

I think in terms of orders, the sector that has been most productive has been in the area of heavy civil infrastructure. It's mostly related to transportation, mobility-related infrastructure spending of the government, be it the high-speed rail, be it the dedicated freight corridor, be it the metro projects that cities are executing. So transportation has been a big area where both the allocation of funds by the government as well as the thrust that they have provided for making sure that the bids are, you know, fashioned and put out consistently, has been a big help. We've also seen water as a major area where we've been able to grow our infrastructure business. And I think India is water-stressed in many parts. We do have this uneven distribution of rainfall, which causes flooding and drought interchangeably.

So many state governments—and this is more of a state government project—many of the state governments have been trying to improve the irrigation facilities and drinking water facilities, and we have benefited from that thrust as well. Over the last five, seven years, I think the government has been working to make sure that all villages are lit. So there has been a considerable number of programmes that have been rolled out in terms of rural electrification. Much of that is coming to an end now. I think much of India is lit now. But we had the benefit of the role of those orders as well in our infrastructure pie.

Residential constructions and commercial construction have resumed. There was a quiet period after the pandemic. But now I think projects are coming up. Obviously, the markets have got far more selective. I think good projects sell and not-so-good projects do not make the cut.

We're fortunate that some of these are under development. Also, much conversation is happening around the development of public spaces. If you speak about railway station development, transit-oriented development, airport development, inter-land connectivity for ports—all of this has got to do with public infrastructure because I think we produce a lot of things but a lot of things do not reach the market because they rot on the way. The logistics management needs a lot of improvement. So all of this would mean investment in warehouse logistics.

We're also building infrastructure for both healthcare as well as sports. We are getting orders from the hospital sector. We are getting orders from the stadium sector. On a very broad-based basis, India has now come to realise that developing infrastructure all around is key for it to take advantage of the global market conditions.

But one thing is for certain, I think the keenness with which project sponsors are approaching the implementation of projects has multiplied several times if I compare over the last 10 years. And that holds us in good faith. And I guess it augurs well for our future as well. Talking about margins, I think the order book that we have is a mixture of orders procured during the difficult pandemic, post-pandemic, post-war time, and orders that we have won in more recent times. For the orders that we have won in most recent times, I have the advantage of looking back at the price levels that got inflated. So the pricing takes into account the inflationary conditions. But the orders that we booked around the pandemic time and just around the time when Russia went to war, were all booked when the input prices were 30-40 percent lower than what they are today.

It was important that we execute the project because unless we complete the project, there is not even a conversation opportunity with the customers to see some compensation for all the additional cost inflation that has crept in beyond their estimation and beyond our estimation. So the results that you see over the last two quarters and in the current quarter, and maybe going forward in the next quarter or two, would reflect slowly the exhaustion of the projects that we have taken under these conditions. And as we get into the fourth quarter of the current year, we will begin to see the mix of recently acquired projects coming into our revenue and, hence, contributing to margins in a fashion better than what they are today. I'm confident about 2025 being much better margin-wise. And if we continue to win the orders the way we have been doing so far, I think we also hopefully will end the current year with a very healthy order book. And that sets in motion the pace of execution for the following year. So volume growth, as well as profitability growth, are what we are forecasting for 2024-25. But then we need to first complete our task for 2023-24.

At the beginning of the fiscal, L&T's management said that growth in revenue will be 12-15 percent and order intake will be 10-12 percent in FY24. Given that in the first quarter, which is typically not a strong one for the company, order inflow was up 57 percent and revenue up 34 percent, are you looking at exceeding the guidance?

We're also coming to terms with this volatility. You're right that the first quarter generally would not be a very large quarter for order intake. And the second quarter will not be a very large quarter for revenue because of monsoon conditions, etc. That's the historical trend. But what we witnessed in the first quarter is a lot of spillover of what was lined up for FY23. Given the nature of these orders being lumpy and large-sized, I think slippage between the quarters takes the percentages on a different trajectory. I do not want to draw a conclusion by saying that around 56 percent growth in order inflow in the first quarter means that I would be able to sit on the lead right through the next three quarters.

We also need to be conscious of the fact that some of the large state elections and Union elections we are heading into and, hence, we're not in a position today to predict the pace at which some of the ordering, etc., will be done. At the moment, we are targeting orders that we want to win during the current year. So the pipeline for the remaining three quarters looks healthy. Our win rate, also the fact that whether all of these projects will go through is something that we'll have to wait and watch for. We didn't want to move the goalpost of guidance within two months of having announced it. We are happy that we have got off to a good start for the year, but we just want to wait and watch for a while before we get some certainty in our mind that we will do better than what we have guided the market for. Looks encouraging, but I would get into specifics after I get some more time on my hand to assess.

In your last interview to Moneycontrol in May, you said the order pipeline is worth Rs 10 lakh crore. And L&T aims to maintain order win rate of 15-20 percent. How are we doing on that front?

The win rate has been around 20 percent. I think we have fortunately been able to maintain the competitiveness at that level. Insofar as the pipeline is concerned, when we did a check as a part of this closing of the first quarter, the projects that are lined up add up to about Rs 9.5-10 lakh crore, and I think Rs 6 lakh crore is essentially for the infrastructure segment. About Rs 3.5 lakh crore is from hydrocarbon. Hydrocarbon, compared to the last time over, has grown in the prospect pipeline largely because of the energy transition work that is happening all around the world, particularly the energy transition work that is happening in the Middle Eastern market. As we speak, we have close to $5 billion worth of orders that we have won in the Middle East for solar energy and green energy initiatives. If that trend were to continue, we could see the pipeline of Rs 3.5 lakh crore that we are estimating coming into play. So with all the rest of the infrastructure area, the industrial capital expenditure, the construction mining sector—all of them put together, maybe Rs 1 lakh crore. So I do see the Rs 10 lakh crore assessment staying good if we have an uninterrupted nine months for the current year.

In the media call on July 25, you mentioned that the Middle East is now changing from being a hydrocarbon-centric economy to a more broad-based economy. Can you explain what you meant by that? What does this mean for L&T?

In the past, largely, our order wins used to be in the area of oil and gas, it used to be either offshore extraction or pipeline or onshore processing. It used to be almost a single-pony trick in a manner of speaking. But of late, the investments that the Middle East is doing has changed trajectory. I think they want to (a) develop a rail network, (b) they want to develop the Middle East as a tourist destination. So a lot of facilities including attracting, you know, large world-stage games like the FIFA World Cup that Qatar hosted so successfully. These initiatives are now changing the landscape of investments. Now that they are looking at more people visiting the Middle East, etc., they're investing also in rail infrastructure. The Middle East, as you know, is largely a road infrastructure-led, commercial real estate-led market. Now they're also building cities. Which means residential buildings and townships will develop.

Now that the entire world is talking about sustenance and green initiatives, the Middle East realises it is extracting and exporting lots of fossil fuel. To compensate, I think all the new builds that they're doing are being done on the back of solar. We do expect the Middle East also to invest in downstream industries like hydrogen and green ammonia and stuff like that. Hence, I find that the investment pattern that the Middle East is taking, particularly Saudi Arabia, is refreshingly different. Fortunately for us, it plays to our strength. All that we do well in India are the areas that they are now investing in. So we do hope that we will stay prequalified for all those opportunities. And these are typically very large opportunities compared to Indian opportunities. The size of projects is $1 billion, $2 billion, and $3 billion quite easily. We are also hedging our bets by trying to form partnerships, and work in a consortium to make sure that we do not have any excessive risk loaded onto our balance sheet in this quest of growing scale.

In the hi-tech business, your order inflows were impacted by deferrals in heavy engineering and defence. Would this business make up in the rest of the year? What are the laggards?

Large investments in India- both private and public sector- that were planned but deferred were the reason for the business slipping on orders as this division would have supplied to these projects. We do believe it is a deferment and not a complete abandonment of the project. Maybe in the subsequent quarters, what we missed out on in quarter one would come through. As far as defence is concerned, it's always delay-prone because of the layers of approvals that a particular project needs to take.

The fact that the government is keen on promoting private sector collaboration along with the existing public sector entities in defence production augmentation also has its own complexities, because from a mindset where everything for defence used to be catered to by the public sector to co-living with the private sector, who by structure are far more efficient, faster and hopefully cheaper/less expensive compared to public sector units, actually creates complexities in the decision-making process. While promoting the private sector, the government cannot be seen as demoting the public sector. So some of the orders that we were expecting in defence in quarter one were deferred. We do believe that we would get a boost in the rest of the year.

You have made substantial progress with your L&T Hyderabad Metro project and you have already chalked out a plan for the Nabha Power (in Patiala, Punjab) divestment. What would be the total divestment that you hope to do in FY24?

I think we will hopefully complete IDPL (Infrastructure Development Projects Ltd, a public-private partnership subsidiary). I think that all the road concessions that we are holding through L&T IDPL where we have signed a definitive agreement with Edelweiss Group, we need to complete. Various approvals are underway. It's a tedious process, because it's about 10-12 assets, and each asset has its own string of approvals. We are working at it, and that is something that we will complete this year. Hyderabad Metro, I think the effort this year would be to make the asset better and better. With every quarter passing, we are walking that extra mile to make sure it gets better. And it has been so that way. I think the status last December compared to last March compared to this June, things have moved both in terms of ridership as well as capital structure. I think we should continue to do that and close the year on stronger ridership and less debt. I think it might take a year or more thereafter before we can even put it on the table for a potential investor because the investor would like to invest when he sees a balanced capital structure, as well as proven ridership. And this being such a large project—a Rs 20,000 crore project—we might have to give ourselves a couple of years to get that done. I don't expect the divestment of Hyderabad Metro to happen this year.

As far as Nabha Power is concerned, the asset is performing very well. The Punjab government is dependent quite heavily on this asset, almost 90 percent PLF (plant load factor) is what we are running. So on a merit-based dispatch order, priority is given to the output that we generate at Nabha Power. Nabha Power has also turned profitable. It is contributing Rs 1,000 crore a quarter of revenue and Rs 100 crore a quarter of profits. But the fact is it is burning coal and, hence, is not necessarily a priority sector for investors to come in. We are still holding out hope that someday just the efficiency of the plant and the robustness of the PPA (power purchase agreement) will find some investor who's looking at some annuity yield for the business asset. But it is difficult to find a single asset owner because normally these investors would like to look at a portfolio of assets. They need to find more similar plants, which are equally efficient, and have equally robust PPAs before they pool them together and invest. So I think it's going to take some work. But at the moment it is not causing any financial stress to us. So we're not sort of blinking too early on that.

You talked about the opportunity in infrastructure in India. From where we stand right now, what are the top things that are making you bullish about the India story?

Well, I think the need to feed hungry mouths, the need to diversify growth, make it more inclusive, etc., seems to be a common theme among the political dispensation regardless of the party. I think people have come to realise and I think demonstratively it has been true that you create more employment, you improve your tax-to-GDP ratio. So the focus is on creating employment. And if you look at employment creation, it cannot be that half a dozen centres or a dozen centres in the country are the only hubs where employment opportunities exist. This has to be taken deeper into the country. If you want to take it deeper into the country, both people's mobility and goods mobility become important. As you get deeper into the country, infrastructure development to support these employment-generating opportunities to subsist in those areas needs to pick up. So it's actually one feeding off the other. The broader theme that the government and the bureaucracy seems to have bought into actually is the core of the investments that come in.

According to me, India is an underserviced market, even for infrastructure, much less for the consumer, but even for infrastructure. Global funds are more than happy to invest. I think what we need to do is have policies and rules and procedures that make investors feel safe and confident. We still today have work to do on the bureaucracy part of it. The approvals do take time. We have to find ways to make that efficient. The intent is there. I think everybody wants to get on with it and see the project's completion, etc. But just the fact that we are moving from one age of bureaucracy to another age of bureaucracy, and digital is helping in this process, is a time-consuming effort. And I think it also takes some generational mindsets. I'm hopeful over the next 10-20 years the set of bureaucrats who will come to administer all the infrastructure development programmes under the political leadership will possibly make it a more attractive place for investors to invest. Once you have the need, once you have the money coming in, and once you have the policy framework supporting it, then I think we need to do a lot of things around not to be bullish about.

You mentioned that among other factors behind the decision for the shares buyback, it is also a kind of a salute to AM Naik, who is stepping down from the company after almost six decades. How does the L&T team, especially the senior management, many of whom were personally mentored by him, plan to bid him goodbye?

The plan for his farewell is to have one more quarter of good performance because September 30 would be the quarter's end. Nothing makes him happier than a very strong set of outcomes. So I think that's one motivation immediately for the quarter. Insofar as life after Mr Naik is concerned, I think we have been nurtured and grown both company-wise and people-wise by him and his philosophies and leadership values. Those are going to stay with us. I hope that we will be able to continue the cause of the company and its shareholders' value creation targets in a manner where people don't refer to it as, you know, Mr Naik's term and post Mr Naik's term. We just want to make sure that we build on the huge body of good work that he has done. And to maintain and take it forward is going to take enormous effort and belief. And I think he's very much around to guide us and he is one of the most accessible persons. If there is some guidance that we would require, we will always depend on him, and we will have his blessings and good wishes.