It will help build cash pool to push growth in core businesses; to add 10% to FY22e core EPS if used to trim debt; ‘Buy’ retained
Larsen & Toubro (L&T) on Monday announced completion of the divestment of its switchgears business to Schneider Electric. This marks a formal conclusion of the biggest M&A deal to date for the company. In line with its ongoing business consolidation, it should help L&T generate the much needed cash pool to support future growth across core businesses.
While we await further clarity w.r.t. usage of the proceeds, a back-of-the-envelope calculation indicates ~5%/10% earnings accretion for FY22 for consolidated/core E&C EPS, should L&T choose to trim ex-services debt (~Rs 615 bn, of which ~Rs 390 bn for core). At a juncture when businesses are battling near-term growth/returns challenges, L&T’s balance sheet heft will pave way for a much stronger business consolidation and greater stakeholder value creation, in our view. Maintain Buy with SOTP of Rs 1,280 (core valued at 16x) .
E&A deal conclusion imparts greater flexibility and firepower
L&T had signed a binding agreement on May 1, 2018, for the sale of its E&A business— low/medium-voltage switchgears (except marine switchgear and Servowatch Systems) business along with the manufacturing facilities—in an all-cash deal for Rs 140 bn. Given recent deterioration in L&T’s balance sheet due to cyclical issues in E&C, commissioning of Hyderabad Metro and NBFC challenges, Monday’s development will enhance investors’ comfort.
Capital allocation to play crucial role going ahead
While cyclical improvement in core business will drive re-rating over 12-24 months, L&T’s judicious use of Schneider proceeds will play a key role in the extent of re-rating and is a great opportunity for management to drive higher stakeholder value creation. L&T’s (ex-services) net debt to Ebitda (FY21) stands to improve from 4x to 3x now.
Outlook and valuation: Important trigger materialised; retain ‘BUY’
Over the past few years, L&T has exited several businesses, in line with its strategy to focus on core EPC business. This has resulted in value unlocking for shareholders while directing management focus to core growth businesses. Conclusion of sale of the E&A business is another milestone in this regard. We maintain ‘BUY/SO’.