FY2017 will be remembered more for internal improvements, belt-tightening (related focus on digitisation), sale of select non-core investments and preparation for a few others (can add 90-100 bps to 12.5% consolidated FY2017 RoE). FY2018 is expected to be a similar year with muted expectation of recovery in domestic and fierce competition in overseas businesses. We revise down our consolidated-ex services estimates by 2-5% and our SoTP to Rs 1,190. Retain Reduce.
Core construction: Preparing itself for another testing year
L&T expects modest pace of recovery in domestic sector, dependent on on-ground implementation of policy measures (for both demand and supply). It sees increase in global investments, in line with projected increase in oil prices, though expects stiff competition as peers find lesser opportunities in home markets. L&T would continue aiming at improving business returns through known levers (strengthening execution, business value unlocking, and working capital reduction) with the addition of digitalisation. The emphasis on the latter is in sync with a marked reduction in employee count, down 40% from FY2014 peak.
Roads: Reasonable performance; decent credentials for a potential InvIT
The roads portfolio could have reported a 5-6% growth in toll collection but for the impact of toll ban and exemption from tolling light-weight vehicles in Gujarat. Debt levels for operational projects would have been flat y-o-y but declined on a reported basis due to SDR at the Halol Shamlaji project. The other two troubled projects (PNG, Chennai Tada) are on the verge of being taken up by NHAI accepting L&T’s case; claim amounts yet to be decided. Exit from these projects at 100% debt and 1X invested book would yield a multiple of 1.5X for the portfolio, which we use in our SoTP.
Potential near-term divestments can add 90-100 bps to consolidated RoE Other key developments in FY2018 include direct ownership of Hyderabad Metro by L&T (taken from IDPL), demerger of the Katupalli port operations and power turbine JV turning PBT positive. The impending sale of Katupalli port, potential divestment of E&A (at a Rs 140 bn EV), monetisation of road assets capable to be put in InvIT and termination payments in the two troubled projects, can increase L&T’s RoE by 90-100 bps.
Change in estimates primarily on weak outlook for infrastructure subsidiaries We marginally revise estimates primarily on weak outlook for infrastructure subsidiaries in Oman and Saudi Arabia (slump in ordering in FY2017) and, bring down our expectations for increase in consolidated ex-services business margins closer to 25 bps guidance for FY2018. Growth strategy – known levers with addition of digitalisation Strengthening execution and operational efficiency: L&T is focused on bringing about cost & operational efficiencies for achieving profitable growth in the competitive business environment. The emphasis is on better contract and project management. The endeavour is to lower costs while maintaining quality and managing complexity.
Business value unlocking: L&T reviews its portfolio and looks for opportunities to divest from non-core businesses for unlocking value. In the year gone by, the company booked gains on part sale of its shareholding in L&T Infotech and L&T Technology Services as well as loss on divestment of stake in the General Insurance business. Emphasis on improving working capital level: L&T was able to bring down its working capital to 22% of consolidated-ex services business revenues at end-FY2017 from 25% levels reported at end-FY2016. It will continue to focus on reducing working capital levels by placing emphasis on speedy customer collections, accelerating invoicing of work completed and reducing inventory levels. L&T has identified digitalisation as a key driver to enhance its global competitiveness. Various digitalisation initiatives are underway to aid project monitoring and enhancing efficiencies. The company is threading in various digital strategies into the business model and also simultaneously building relevant capabilities to harness the true power of digital assets.
Outlook: FY2018 likely to be a year of muted recovery in growth Indian construction sector: L&T envisages modest pace of recovery, linked to the
on- ground impact of policy measures including the release of 75% arbitral award and the availability of funds for project development. It expects significant improvements in the liquidity profile and credit metrics of construction companies to take time and the same to be contingent on an improvement in the working capital cycle and in the pace of execution, besides their ability to deleverage.
Global construction sector: L&T expects investments to increase through 2018, in line with a projected rise in oil prices, but to remain far below the historic highs of 2012 and 2013. Digital in Construction: A range of solutions targeted at reducing operating costs, improving productivity, enhancing safety, and reducing execution time are being implemented.