L&T margins should improve in Q4 of current year and next 4 quarters: CFO

What is the biggest advantage L&T has started the year with?
The biggest advantage that we have as we started the year was a very healthy order book. Nearly Rs 4 lakh crore of orders meant that we had to get on a fast track in terms of execution and in our industry, as we work under the skies, April-June is a good quarter because we do not have interruptions from monsoons etc. So generally, we get quickly on to completing projects in the first quarter.

The biggest driver, if I may call that, is that most of these are marquee projects and they are under supervision of either the world financing bodies, multilateral agencies or are priority projects for the government – both state and centre. So the extent of oversight and the support that we had received has also been very encouraging and this has helped us move ahead.

We are possibly just leaving the Covid impact behind. We have been able to mobilise resources in our various project sites and get going on that front. That has been the real reason for revenue growth. EBITDA is a function of the volume growth that we have been able to achieve on the top line. Profitability is something that we are working on because there is room for us to improve. We are still observing the effect of inflation of the post-Covid, post-war period. But through the course of this year, we will slowly get that out of our charts and we expect 2024-2025 to be a much better year.

Given that we have seen pick-up in domestic execution, that also has contributed to your margin improvement. When can we see the completion of legacy projects and in turn, where do we see your margins headed?
If you look at our mix, out of Rs 4 lakh crore of orders that we started the year with, nearly Rs 2 lakh crore worth of orders were picked up during FY23. FY23 was a period where we could afford to factor in the inflation prices etc. So to that extent, the ability to anticipate the price trends was better. What we call legacy is the projects that we picked in 2021-2022. Now these were picked up at a time when inflation was raging and it was becoming a big task to predict the cost lines over a period of 12-24 months. As most of us normally do, we did our best estimate and went into the contracts.

When we execute the contract, the commitments that we have made for various sourcing actually starts coming through in the subsequent quarters. Being a project business, there is a lead lag between the time we commit for the inputs and supplies and when the supplies actually come in to our project sites. What we are seeing in the last two quarters of FY23 and the current quarter that we just reporting have seen the impact of this cost inflation. We do expect the next two quarters to have the trailing effect of cost inflation.

I believe that from Q4 of the current year, the mix of orders that we are executing will become a little more biased towards better priced contracts. So to that extent, the last quarter of the current year and the next four quarters of the following year should indicate improvement in our margins.In your overall prospect pipeline, hydrocarbon is the key growth driver. Do you think that hydrocarbon as a segment along with heavy engineering will continue to see improving margin trends?
Almost 60% of the projects that we have won in hydrocarbons are projects that we have won overseas. What happens in overseas projects is they intrinsically are much larger in scope and size and that gives us the advantage of working with a larger global supply chain and the scale effect also comes into play. The ability to work on larger projects gives us an advantage as compared to the Indian projects which are far lesser in size. Whether it is a small or a large project, we make sure to put the best team to work at these various project sites.

The ability to absorb costs in larger projects is much better. We expect the margins to be stable. I do not expect hydrocarbon margins which as it is are healthy to run away much beyond where we are. But we would be able to operate around the levels that we are currently reporting. In the first quarter, we reported hydrocarbon margins of around 9.1%. Working in a band of nine quarters is a good place to be in as far as hydrocarbons are concerned. As far as heavy engineering is concerned, this largely supplies equipment custom made to client’s requirements, mostly to heavy hydrocarbon industry as well as to nuclear industry.

Intrinsically manufacturing operations have a better margin profile because the entry barriers are pretty high and we have over 30 years of experience in working in some of these process technologies and complicated engineering technologies. We do believe that the margins of mid-teens for manufacturing activity of hydrocarbon equipment through the heavy engineering business will sustain.

Let’s discuss that mammoth Rs 10,000-crore buyback that the company has undertaken. Given that you desire to reach an ROE of about 18% by FY26, will we see more distribution in the form of buyback and special dividends down the line as well?
This buyback has been part of the programme that we have set ourselves for in this ROE improvement journey. It is part of Lakshya 26, the five-year strategy plan that the company is working on. We had to make sure that we are in compliance with the regulatory requirements. Last time over when we attempted to do a buyback, there was certain ambiguity in the regulations and hence we could not complete the programme.

We had subsequently worked with Sebi to make sure that necessary clarificatory guidelines are in place. Today, we think that what we actually started thinking of doing three-four years back, we are beginning to get on track with that. Our business generates a fair bit of cash. We are not very capital intensive by nature. We are more working capital intensive which is short-term cash flows. If the company continues to win impressive orders, executes well and profitably, the ability of the company to generate cash on a consistent basis is high.

It does not have much debt on its balance sheet. If you set aside the financial services business, there is not much debt that L&T as a group has at all. Particularly the standalone company of L&T has about Rs 20,000 crore of debt which is pretty modest when you compare the size of operations of the company. All the cash flows that accumulate either needs to be done for investing in new areas or needs to be returned back to the shareholders.

While investing in new areas, we have to be very selective because over the last 10 years, we have invested in certain areas which actually have not produced the desired returns for the shareholders. The concession assets, for example, that we invested big time in, did not really produce the desired returns.

Hence, we are in the course of divesting those businesses. Given the selectivity of investment, we will possibly invest in LNG transition in hydrogen-related business. So we are setting up an electrolyser manufacturing facility for making electrolyser equipment which helps manufacture hydrogen. We would like to invest in futuristic areas such as those.

But in any case, as a strategy, we are looking at asset-light return high areas of operations. Consequently, the cash that gets generated beyond the requirement of the company is meant for shareholders. And that is the path we will take. Returning money to shareholders can take a couple of forms. Dividend is one obvious way of providing a return back to the shareholders. Buyback is a good way. And buyback will not happen as regularly as dividend which is an annual feature. But once in a while, when we are able to accumulate sufficient cash surpluses, buyback along with a normally healthy dividend rate will be the way to go.

You have largely maintained your guidance. But given that you have seen a strong order pipeline, there is expected lumpiness in the ordering environment during the pre-election period. Don’t you think it is more on the conservative side? Will you re-look at this? Look at perhaps a division on the upside?
We tend to review the guidance that we give to the market once in six months. We gave guidance for FY24 in May, when we announced our results. To come back and tweak the guideline in July seems a bit premature. We are happy and fortunate that we have got off to a very good start in the current year. But as you know, there are three more quarters that we need to perform. And uncertainties are part and parcel of our business life. We just want to make sure that we assess the conditions. We do not want to be seen as somebody who keeps reacting to quarterly developments. We want to be a little more stable.

Inherently, we are a conservative company. We do believe that we need to deliver on our performance. I cannot be but realistic in whatever we commit to the markets. But having said that, we are operating in a project business which is very lumpy and non-linear. So who knows? If the conditions are such that it gives us confidence that we should be able to revise the guideline, we would do this. But maybe, one more quarter down the line would be a little better time to even debate about this.