Over the past decade, L&T has experienced significant growth in its core E&C business’ working capital. Our analysis suggests that in the core E&C business, working capital has increased by Rs 148 billion for L&T over FY10- FY18 (a rise of ~5x). As a percentage of E&C sales, this number has risen from ~7.3% in FY10 to ~19.1% in FY18 (peaking in FY16 at ~23%). During the same time frame, the comparable E&C revenue base has gone up ~3x.
While L&T is itself targeting an 18% working capital/sales level by FY21 (down from ~19% currently) as part of its Lakshya 2021 targets, we believe L&T’s core E&C WC level could reduce to 15-16% of sales by FY21F, thus releasing ~`50-60 billion of cash for the company.
As a comparison, L&T’s proposed buyback is for a size of Rs 90 billion (~4.29% of outstanding shares). Over the past decade, L&T has had a significant growth in its core E&C business’ working capital. This has impacted it in the form of higher interest cost as well as lower return ratios. At the same time, due to various accounting and segment changes, it is often difficult to compare the WC build-up for the core E&C business over a long time frame.
While revenue growth has led to an increase in overall WC, clearly there has been a significant increase in the intensity of the WC cycle as well.
Some of the key reasons that have driven this acceleration in the WC cycle over the years are: 1) L&T’s aggressive push into the real estate contracting business during this time frame, which is inherently a higher WC intensity business. To illustrate, L&T’s exposure to real-estate contracting business was minimal prior to FY09. However, by FY16 it had become amongst the largest contributors to annual order inflow for the company before slowing down in FY17-18. 2) Increase in collection days from customers both in the real estate contracting business as well as other E&C domains, led by economic slowdown and associated challenges. We believe this is a cyclical problem,and almost always a turn in economic cycle impacts the WC cycle for companies in the E&C space. With a potential economic turnaround coming up again, we believe WC levels may shrink again.