Is the Worst Over for L&T?

The recent conflict in the Middle East, coming soon after Russian invasion of Ukraine, has heightened geopolitical risks. Surging energy prices and higher freight costs due to logistical issues have stoked inflation.

Meanwhile there are other risks like elevated real interest rates, weaker-than-expected growth in China, further trade fragmentation, and climate change-related disasters that can impact global infrastructure spend.

What does this mean for India's largest infrastructure conglomerate L&T?

Let us go back a few decades.

In the early 1950s, with import substitution at the heart of India's industrial policy, L&T began producing machinery and equipment for core industries like cement and steel. Since then, it has been the hotbed of innovations.

India's first hydrocracker reactor with the Made in India label was manufactured in 1989-90. Close to a decade later came the nuclear reactors.

And then the making of the hull of India's first nuclear-powered submarine, INS Arihant. Its latest feat was assisting in the launch of Chandrayaan - 3. So, the 'Make in India' drive began in L&T decades ago.

Then came the necessity to stick to core competencies.

The clean-up involved selling 16 businesses that were either not core to L&T, or too small for the managerial and technical bandwidth they called for, and yet didn't make a profit.

Among these were businesses that were entered into during the Licence Raj because they didn't call for a licence, like shipping, footwear and bottle-making. The company exited the cement business too and focused on higher quality construction of dams, bridges etc.

Over the years, several new businesses like IT services, aerospace, defence, real estate, nuclear, heavy engineering and hydrocarbons have become L&T's new growth areas.

The company is now looking to add data centres and semiconductor fabrication to the list.

With several subsidiaries like L&T Tech and Mindtree that help in innovation, the company is one of the most well geared to cater to global infrastructure needs.

But where are the opportunities?

Middle Eastern countries, particularly Saudi Arabia are expected to front load their oil revenues into infrastructure development as part of their plans to diversify their economies beyond oil.

Companies in advanced economies are working to diversify their supply chains away from China, which will support investments in logistics infrastructure in countries such Vietnam and Indonesia.

L&T already has a strong order book of Rs 4.9 trillion, providing a visibility of 2.5x on revenues. This should help L&T sustain healthy revenue growth over the next few years.

However, apart from the geopolitical crisis, order inflows for L&T have remained weak so far in 2024 mainly due to a weaker-than-expected revival in domestic ordering.

Elections, weak spending from the central government and lower-than-expected awarding from the private sector have resulted in subdued domestic ordering.

After the state elections, ordering should start ramping up from segments like transportation (metro rail), energy, minerals and metals, water projects, and defence. International ordering is also expected to improve from renewables, natural gas, and transmission.

Having a strong order book, is although, not enough. Execution is key to profitability of infrastructure companies. Since the Middle East crisis is here to stay, L&T may have to ensure that its geographical exposure is well diversified.

Plus, there is stiff competition in project bidding.

L&T has been facing increased competition in domestic projects, for which other EPC majors, such as Megha Engineering, Tata Projects, Afcons Infrastructure, and IRCON, have started bidding aggressively, even for larger-sized orders.

To keep its order book growing L&T is continuously targeting opportunities from sectors like nuclear power, thermal power (selectively), defence, and transmission (international as well as domestic).

Over the medium to long term, there is growing interest in setting up nuclear power capacity, where the company sees an annual tendering opportunity of 2-3 GW.

Similarly, there is a renewed emphasis on thermal power, through JVs. In the defence space, L&T aims to capture opportunities from land-based weapon systems, naval ships, battle tanks, mounted guns, etc., given its long track record, R&D investments and capabilities.

The company typically refrains from entering into a bidding war and adopts a selective approach to tenders that meet its profitability, working capital and execution criteria.

This is also one of the reasons for lower ordering in the domestic market, where the company has prioritized margins and working capital over order accretion.

Over the last two years, L&T's margins were impacted by legacy projects and sharp fluctuations in commodity prices. The company's current order book mix is around 60% toward variable pricing contracts and 40% towards fixed pricing contracts. So, the margins do have a scope of expansion.

With most commodities being range-bound in current financial year and the expected completion of legacy projects in the current year, we expect margins to start inching up gradually. But near-term hiccups cannot be ruled out.

Competition with existing peers and the listing of Afcons Infra (Shapoorji Pallonji group) can certainly add near term pressure to the P/E valuations of L&T.

L&T Versus Afcons and Other Peers

But as we can see in the IPO prospectus of Afcons, despite its size, L&T remains one of the most well hedged in the event of a heightened Middle East crisis.

Also, the company's book to bill ratio (showing revenue visibility of order book) is the highest amongst peers.

Therefore, while the possibility of near term P/E dilution remains, L&T's robust financials (refer fact sheet here) give the stock sufficient tenacity to ride through the crises.

Warm regards,


Tanushree Banerjee
Editor, StockSelect
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)