At the beginning of FY21, infrastructure activities were restricted during the first wave of Covid-19. With economic activities resuming, the infrastructure sector bounced back. Higher capital expenditure (capex) spends and the government’s infrastructure impetus put infrastructure in focus. But then the second wave stopped it in its tracks.
Larsen & Toubro (L&T), the largest Indian infrastructure company, faced a host of challenges due to Covid-19, rising commodity prices, labour shortages, and curtailed operations. L&T managed to end FY21 with higher revenues and profits compared to pre-Covid levels, and recorded order wins of Rs 1.7 lakh crore, but uncertainties remain.
The company’s Hyderabad metro project is burning cash, forcing the company to divest its stake in its thermal power plant to the Punjab government for Rs 9,700 crore to make up for the declining cash flows. The second wave has caused a labour shortage, which is expected to delay operations till Q3FY22, impacting revenues. Entering FY22, the company might be eyeing further order wins but this is coming at a cost.
Profits declines in Q4, but management optimistic on margin expansion
In Q4, L&T’s standalone revenues (infrastructure, power, engineering, and hydrocarbons) came in at Rs 29,754 crore, a 9.2% increase YoY. The revenue growth was on the back of order inflows worth Rs 50,600 crore in the quarter.
Net profits declined by 3% YoY to Rs 2,031 crore due to higher input costs of construction materials like pet coke, iron, cement, industrial packaging materials, and fuel.
Earnings before interest tax, depreciation, and amortization (EBITDA) margins were higher by 180 basis points due to the company passing on rising commodity prices to customers.
L&T’s EBITDA margins in FY22 are expected to sustain, not just because of commodity price corrections. Around 60% of L&T’s order book consists of variable price contracts. This means that if commodity prices rise further, the company can renegotiate provisions to prevent operating expenses from increasing.
Infra-order book resilient, hydrocarbon orders grow in H2FY21
L&T’s standalone operations consist of four segments - infrastructure, power and transmission, and engineering (heavy, defense, and hydrocarbons). The infrastructure segment earns the bulk of the revenues (80%), but its margins are low, at 10.5% in Q4. The heavy and defence engineering segments’ margins are healthy at 25-26% and grew by 9.2 and 13 percentage points respectively in Q4 on a QoQ basis.
The margins from the infrastructure business remain subdued due to deferred order payments in H2FY21. The company expects to receive these payments from the public and private sector only in the second half of FY22 once economic activity reaches pre-Covid levels. Hydrocarbons’ bagged orders worth Rs 16,500 crore in H2. This is expected to add to earnings and expand its margins only in Q3FY22 when operations resume.
L&T’ has been getting infrastructure orders since the unlocking of the economy began in Q3. Companies operating in the power, cement, chemical, and automobile space delayed planned capex from H1 to H2 when demand recovered. This order backlog helped L&T’s order inflows grow three-fold YoY in H2FY21 to Rs 76,000 crore.
The biggest order in FY21 was the Mumbai-Ahmedabad bullet train project, which L&T won in October 2020. The project is worth Rs 25,000 crore and L&T will construct over 500 kilometers of the high-speed railway project from Vapi to Vadodara.
While L&T’s construction order book (excluding infrastructure) is quite small, it grew by 5% YoY in Q4 led by hydrocarbons. The company got orders worth Rs 47,000 crore in the power, heavy engineering, defence engineering, and hydrocarbons segments in H2FY21. The hydrocarbon segments’ order wins were 47% of the order book, excluding infrastructure, in H2FY21. The growth in the hydrocarbon order book was due to a revival in oil exploration and refining activity and a surge in the price of crude oil in Q3.
Heading into FY22, order wins will be concentrated in the infrastructure and hydrocarbons space. With commodity prices rising, L&T expects to receive orders from mining and oil exploration companies. The management said its power segment will focus on renewable energy in FY22. In FY21, power order inflows dropped by 93% YoY to Rs 940 crore. In April, L&T won orders worth Rs 5,000 crore to build a solar-energy facility in Saudi Arabia.
Hyderabad metro burns through cash
A key drag on the company’s cash flows is the Hyderabad metro project. At the end of FY20, because of India’s first wave of Covid-19, metro operations were halted. With the nationwide lockdown imposed in March 2020, L&T allocated Rs 2,000 crore to manage the cash burn of the metro project in FY21 (up from a Rs 1,000 crore allocation in FY20).
Due to low ridership in Q3 and early Q4, the project burns Rs 4,500 crore per quarter and makes a loss of Rs 300 crore a month. This has only worsened in the second wave. Even if the ridership revives in H2FY22, brokers expect the project to burn 55% of free cash flows in FY22.
For FY22, L&T has allocated Rs 2,000 crore to cushion the losses of the metro project. In order to raise funds and prevent any further cash burn, the company is looking to divest a part of its stake in the project to the Telangana government. It also plans to approach the government for refinancing options. The funds generated will be put into its core infrastructure business. In addition to this, the company has also made an offer to the Punjab government to sell its thermal power plant in Rajpura for Rs 9,700 crore. The plant provides 1,400 megawatt of power to Punjab.
The management is not looking at divesting its entire stake in the Hyderabad metro project. It has a concession period of 60 years and expects ridership at 7 lakh commuters a day. But breaking even looks difficult in the short term as the company expects ridership to remain muted in FY22 for the Hyderabad metro project, and making a profit seems like a distant dream. The Hyderabad metro project generated revenues of Rs 200 crore with a net loss of Rs 1,700 crore in FY21.
Execution curtailed due to labour reduction
At the end of FY21, L&T had orders worth Rs 3.3 lakh crore, a decline of 2% compared to FY20 orders. The order book will be accompanied by projects worth Rs 9.6 lakh crore in the domestic and international market in FY22. The management did not disclose if they have placed a bid on these upcoming orders but said the pipeline for FY22 is healthy.
L&T’s construction and engineering activities reached pre-Covid levels only in Q4. In April 2021, operations were briefly halted but resumed once state governments allowed infrastructure activities to continue. This was unlike in 2020 when April and May saw restricted construction activity due to the nationwide lockdown announced by the Centre.
L&T had 2.4 lakh workers on its rolls in March 2021. The management wanted to increase the labour force by 14% in Q1FY22 as orders worth Rs 3.3 lakh crore were still pending. Due to the second wave of Covid-19 infection, and lockdowns in the National Capital Region, Maharashtra, Karnataka, and Tamil Nadu, nearly 20% of L&T’s workforce returned to their hometowns. Even with cases decreasing and a gradual unlock of the economy expected by June, the management is not optimistic about a revival in the execution of projects till the beginning of Q3FY22.
This slow revival in execution of orders is expected to cause a reduction in operating cash flows. which grew by 2.4x in FY21 against the previous year. However, brokerages expect the lack of cash flows to be cushioned by the number of public-sector orders. This is because the risk of public sector customers deferring or defaulting on payments is low compared to the private sector customers.
Out of the Rs 3.3 lakh crore order book heading into FY22, 79% are from the public sector (central and state governments and PSUs). The management indicated that out of the Rs 9.6 lakh crore infrastructure pipeline for FY22, 55% is in the public sector. Since L&T already has a strong public sector infrastructure order book (Rs 2.6 lakh crore), brokerages expect the company to secure public sector orders in FY22. L&T’s public sector heavy order book (79%) also provides safety from credit-default risk, due to non-payment of dues.
The management is optimistic about public-sector infrastructure spending and private companies’ capex cycles resuming in the second half of FY22. On the basis of these expectations, L&T’s management in the Q4 earnings call gave a guidance of a 13-15% order and revenue growth in FY22 order inflows to over Rs 2 lakh crore. L&T refrained from giving any guidance on revenue and order wins in the previous quarters of FY21. But with labour shortages, and the cash-burning Hyderabad metro project, Larsen & Toubro has a host of uncertainties in FY22, no matter how big its order book looks.