Given that the company’s revenues are back to pre-Covid levels, the company is now targeting to return to its RoE (return on equity) trajectory. L&T’s chief financial officer, R Shankar Raman, in an interview with Malini Bhupta explains the road ahead. Edited excerpts:
The government’s Gati Shakti and PLI scheme are expected to improve domestic order inflows for Larsen & Toubro (L&T). Given that the company’s revenues are back to pre-Covid levels, the company is now targeting to return to its RoE (return on equity) trajectory. L&T’s chief financial officer, R Shankar Raman, in an interview with Malini Bhupta explains the road ahead. Edited excerpts:
L&T continues to follow its strategy of internationalisation. What is the reason for strong order inflow from overseas during this time when the pandemic has struck hard across the board?
Not being entirely dependent on India is a long-term strategy for the company. This is not a tactic for a certain point in time and the idea was that if the company has to scale, it has to look at opportunities outside India as well. Being an investment-led business, the projects are done to create capacity. After a period of capacity creation, there is a period of lull when capacity gets utilised and this cycle repeats. We felt that if the company has to be consistent in its performance, it has to broadbase its businesses. On a longer-term basis the mix of 70:30 between domestic and international orders will continue.
In Q2 FY22, the international share has been pronounced because the nature of the orders were such that they were lumpy. We do believe that in subsequent quarters we could see lumpy domestic orders, which could move the share of domestic orders up. Our assessment is that over a period of a year, international orders will be in the range of 25-35% of total order flow. The fact is that we are straddling a wide array of sectors. In current times since oil prices have started moving up, investments in oil are seemingly justified. This has led to a spurt in hydrocarbon orders. The value addition for product streams have widened. The hydrocarbon industry in the Middle East is now investing in downstream capacities onshore and not just in offshore wells.
Private capital expenditure has not been picking up pace for a variety of reasons. Which sectors are seeing a pick-up in capital expenditure?
Statistically speaking, private capex in our pool of projects was pretty low at 12%, but have inched up to 19-20% today. The reason why they have recovered is due to strong prices of steel and derivative products. All steel majors are investing in capacity argumentation. China pulling back on exports and the trade pact between the US and China cracking, there was an opportunity for Indian steel makers to export. It has contributed to the step-up in private sector capex. In the past, private capex was heavily driven by the infrastructure sector. Over 5-7 years, players realised investing and holding infra assets was not easy since exits proved challenging. As the private sector started vacating this space, these assets were sold to private equity funds, pension funds, and sovereign wealth funds, which hold many of these infra assets. Private infra players have started using capital unlocked to repay their debt. The government has not been successful in reviving broad-based private sector investment momentum in the infrastructure space. The good performance by the IT sector despite the pandemic has attracted the attention of growth capital. Most IT majors have started once again developing their own campuses and delivery centres, BPOs and KPOs. The other connected sector has been data centres. The stable environment India provides has attracted global technology majors and hyperscalers to look at India. We expect the minerals & metals sector, data centres and technology majors to drive initial private capex.
Five years ago, the company had committed to achieving some financial targets. Have you achieved them?
The overall target was RoE improvement, from 9% at the start of 2016-17 to 18% by FY 20-21. Up to FY19, we were well on our way to reaching the target. A normal FY20 and FY21 would have seen us getting to 18% RoE. We never look at stock price as a target. We believe that value creation will be through higher RoE. There are several sub-parameters to our targeted RoE. We had to make sure profit after tax was strong and our balance sheet stable. The dividend payout to shareholders was conservative at 25% of profits earned. We have stepped it up to 45% as profit pool increased and new opportunities for investment were not immediate.
We attempted to do a buyback as we had good net worth but Sebi thought otherwise, because we run a financial services company that is levered. And in group consolidated debt/equity ratio the debt of the financial services business gets consolidated in our balance sheet, even though there is no recourse to the parent company. Today, financial services is geared moderately at 4x compared to the 6x it was back then when we attempted a buy-back. We want to get back on the RoE growth trajectory. Shareholder value creation through better payouts, higher RoE and possible buy-back and regulations permitting will be on our agenda. A lot of this also depends on our successful divestment programme of non-core businesses/assets.
What are the factors that will work to the advantage of public projects?
The lead will be taken by public programmes funded by multilateral agencies. The best thing to do is to develop programmes that tick the developmental agenda of these multilateral agencies. Private sector capex will pick up and we have to be patient until the environment for return on investment becomes predictable. If you look ahead there are several challenges. First, the government programmes have to be well conceived and should be implemented without bureaucratic hurdles. The steps that the government has taken on an integrated infra development programme under its Gati Shakti initiative is to eliminate development in silos. If this happens then we are at a good place to start with, as capital would become available. It needs good programme management with availability of good contractors to execute. However, the government generally seeks safety in numbers. If there are many entities bidding, then price discovery is believed to happen better. This, however, is not necessarily so in infra project development. If it is purely price-led infrastructure development, then there are chances that there will be delays, technology could be sub-standard and lifecycle cost of projects would be higher. The policymakers in the government need to look at the bigger picture as resources are available.
Do you see ordering coming out of the PLI scheme?
If you look at the outlay for PLI schemes, it is about $22 billion across 13 sectors. This would mean distribution of approximately Rs 1.65 lakh crore across sectors. Electronics components and telecom is one of the biggest beneficiary of the PLI schemes. Such spread of allocation creates fractured opportunities. The opportunity has to be of scale for cost efficiencies to work in our favour. These are early days and capacity creation has not begun significantly on the ground yet. The other sector of focus for the PLI schemes is automobiles. The big factories, like the upcoming Ola factory that we are building, is something we will look at. The other area of interest is battery-storage facilities. We will look at EPC opportunity in this area, as we have the capability. All in all, nearly $12-13 billion of EPC opportunities could arise through the PLI schemes over time.