What L&T’s results tell us about India’s infra sector

The post earnings commentary put out by the management of engineering major Larsen and Toubro (L&T) on January 22 should serve as an indication of all that is problematic with the Indian infrastructure sector. At a time when economic growth has slowed down considerably, the government would do well to take a cue from it and work internally as well as with other stakeholders like state governments and private sector companies address, at least, some of the pain points that the industry is facing.

L&T reported a 6% year-on-year rise in consolidated revenue from operations for the quarter ended December 31, 2019, to ₹36,200 crore. Its EBITDA (earnings before interest, tax, depreciation, and amortisation) grew 10% to ₹4,100 crore and profit after tax rose 15% in the same period to ₹2,400 crore. The order inflow for the third quarter of FY2020 came in at 2% higher than the corresponding quarter of FY2019 at ₹41,600 crore. Though growth was tepid, it was above Street expectations that had expected the Mumbai-based company to report a decline in order inflow.

The earnings are surely not as bad as they could have been. But that is more a function of weakness in the domestic business being offset by L&T’s international business, its execution skills, and a recent focus on letting go of asset-heavy businesses. On the back of growth in its international business—predominantly in the infrastructure and hydrocarbon business verticals—L&T is confident that it will be able to achieve order inflow growth of 10%-12% in FY2020, which it had guided earlier. Most analysts had expected L&T to revise its growth target downwards.

In the first nine months of FY2020, international orders account for close to 24% of L&T’s order book of ₹3.06 lakh crore, up from around 21% in the same period of FY2019. On Thursday, L&T’s shares were trading on the BSE at ₹1,328.10 per share, up 2.62% at 1.32 pm. The bourse’s benchmark index, S&P BSE Sensex was up 0.55% at 41,341.82 points at the same time.

At a post-earnings press conference on January 22, R. Shankar Raman, L&T’s whole-time director and chief financial officer, described the last quarter and nine months ended December 31, 2019, as “challenging.” “Economic growth has slowed down considerably and that is not good news for companies like ours that depend on investment momentum,” Shankar Raman said. “The biggest challenge right now is that there aren’t enough new jobs and consumption and discretionary spending has come down. People are also moving out of asset classes like real estate because of this.”

Recently, the International Monetary Fund (IMF) reduced its economic growth estimate for India to 4.8% in 2019-2020, versus 6.1% projected earlier in the year. Ratings agency India Ratings and Research expects India’s GDP to grow at 5.5% in FY2021 even as the economy continues to suffer from low consumption and investment demand.

In a tell-tale sign of the challenges in the infrastructure sector, L&T’s revenue from this segment fell 5% year-on-year to ₹17,250 crore in the October-December 2019 period.

Shankar Raman explained that various factors playing out in different parts of India posed execution challenges to orders already with the company that led to a revenue decline. For instance, a public interest litigation filed against the coastal road project in Mumbai held up work; a change of government in Andhra Pradesh led to a review of the earlier administration’s plan of developing Amravati as the capital of the newly carved-out state; and severe air pollution led to a complete halt in work for a good 30-45 days in the National Capital Region. These issues also led to a bit of strain on L&T’s working capital requirement.

L&T’s chief executive officer and managing director S.N. Subrahmanyan consequently outlined a few issues that were leading to a delay in infrastructure contracts getting awarded. He explained that for very large infrastructure projects, L&T’s bids were coming in higher than what the government budgeted for these works. “Usually, the government settles for 10% more, but since some of these budgets were framed three-four years back, the government calls for re-bids, which leads to a delay of a few months,” Subrahmanyan said. He also added that for some other projects, L&T was the only bidder. In such cases CVC (Central Vigilance Commission) guidelines mandate calling bids twice or thrice more and if a company is still the lone bidder after multiple rounds, then it gets the project.

“Certain projects like the high-speed rail corridor, road expansion and river interlinking are going low. But we feel that this is a temporary phenomenon and the pace should pick up,” Subrahmanyan said.

In this backdrop, all eyes are naturally on the upcoming Union Budget on February 1 which will be tabled during one of the most crucial periods of time for the Indian economy, within the two consecutive tenures of the current Narendra Modi-led government.

“The Budget can't solve all problems. It can only serve as an indication of the approach being taken by the government,” Shankar Raman said. “The biggest constraint today is funding. There should be some indication on how the government is planning to deal with this situation.”

Despite the present challenges, L&T, which reported a turnover of ₹1.41 lakh crore in FY2019, remains optimistic about the future. Shankar Raman said that the economic agenda was “coming to the front-burner” after a period of political distractions. This was evident from the in-depth consultations with the industry that the government has undertaken in the last few weeks. The company’s management also said that there were indications that the central and state governments were starting to spend more on infrastructure projects, though the private sector was still sitting on the fence. The cycle of subdued demand and investment in infrastructure should reverse in the next 12-18 months, it feels.