Larsen & Toubro (L&T) expected a difficult start to FY22 as multiple states imposed lockdowns and the pace of commercial activity declined, infrastructure work slowed down. This put L&T in a grim position, especially with the momentum of new order wins waning during the quarter.

India’s largest domestic infrastructure company saw a significant decline in infrastructure orders, but orders for its small but growing hydrocarbon segment rose in Q1FY22. The company expects healthy orders in both these segments, in addition to power and engineering, for the rest of FY22. However, its key Hyderabad metro rail project is burning nearly Rs 900 crore a quarter. Will L&T be able to overcome the impact of the second wave?

Revenue and net profits sharply decline due to lockdowns

The lockdowns in Q1FY22 were not as restrictive as those in Q1FY21 as a result of which standalone revenues increased by 61% YoY to Rs 13,109 crore. However, as infrastructure operations staggered, L&T’s infrastructure revenues fell 60% sequentially to Rs 9,781 crore. Standalone net profits were up 2.6X YoY to Rs 750 crore but fell by 63% sequentially.

The company’s EBITDA margins took a big hit in Q1FY22 as operations were disrupted and input costs were elevated. Unlike Q1FY21, the prices of coal, petcoke, steel, rubber, cement, and packaging materials were higher in Q1FY22. This led to a 280 bps YoY decline in L&T’s EBITDA margins to 12.9%. Input cost pressures for construction companies began in Q3FY21, since then it weighed heavily on L&T’s margins.

Input cost pressures on the construction sector were high throughout the quarter. The price of inputs like crude oil, coal, petcoke, steel, copper, and freight fuels have been soaring in 2021. Around 60% of L&T’s contracts with customers allow for the company to pass on rise in costs. This means the company can renegotiate contracts with customers if costs rise.

Interestingly, margins of L&T’s infrastructure segment (80% of orders) was 5.3% in Q1FY22, higher than two years ago (4.8%). Brokerages suggest this means commodity price inflation is negligible so far for the infrastructure company. The fact that the majority of its contracts allow for passing on the rise in costs suggests that L&T can ward off a further rise in input costs.

Infrastructure order inflows slow down due to the second wave

In Q4FY21, infrastructure orders momentum was strong as power, cement, chemical, and automobile companies deferred capital expenditure (capex) of H1FY21 to H1FY22. Public sector companies also spent heavily on infrastructure projects and L&T won several projects. In H2FY21, the company received orders worth Rs 76,000 crore, a 3x growth against the first half. However, this momentum stopped short because of the second wave.

Private and public customers were wary of handing out contracts to companies during the second wave. In Q1FY22, the company won orders worth Rs 15,200 crore, 44% lower YoY and 8% lower than the previous quarter. The company’s order book backlog stood at Rs 3.23 lakh crore in Q1FY22, 6% higher YoY.

Due to lockdowns in several states in Q1FY22, L&T’s infrastructure order book backlog grew by 11.2% to Rs 2.46 lakh crore. Total infrastructure order inflows were Rs 11,170 crore, lower by 1% during Q1FY21 when all infrastructure activity was halted because of the national lockdown.

L&T’s management said tendering of orders was low as customers, especially public sector customers, were wary of placing infrastructure orders. This is because of the delayed pace of execution of infrastructure activities due to another reverse migration of labourers from urban to rural areas during Q1FY22. 

During the first wave, nearly 70% of L&T’s workforce migrated to hometowns. When the second wave struck, reverse migration threatened the pace of order execution. Before lockdowns, L&T had 2.4 lakh labourers on its rolls, 5% below peak levels. In April and May, its labour force dropped by 30% to 1.7 lakh labourers.  As governments allowed commercial activity to carry on, the company didn’t see a considerable reduction in its workforce like in Q1FY21.

With lockdowns easing in June, its labour force was 95% of March 2021 levels and 90% of peak levels. Brokerages suggest this is a strong sign and that order execution will pick up in the coming quarters. However, the monsoon season could result in a decrease in L&T’s labour force as part-time labourers return home during kharif sowing season. While L&T’s Q2FY22 labour force is sufficient, there could be a decline in the workforce towards the end of the quarter. With the infrastructure order backlog already at Rs 2.46 lakh crore and more orders expected in Q2 and Q3, a stable labour force will be vital for L&T.

Hydrocarbons orders continue the order momentum

A key segment that performed well despite the lockdown was hydrocarbons. Under this segment, L&T provides construction services to oil and gas, petroleum refining, chemicals, and fertilizer companies. The hydrocarbon segment made up 54% of the company’s order book (excluding infrastructure).

In Q1FY22, L&T’s hydrocarbon order inflows fell by 12.2% YoY to Rs 1,064 crore, the lowest in two years. However, this was down to delayed awarding of orders from international customers. The company expects to receive hydrocarbon orders worth Rs 1.8 lakh crore in FY22, 70% of which will be from oil and gas companies in the Middle East. The key for the company would be timely execution of these orders, accruing to L&T’s top line.

The hydrocarbon segment’s revenues in Q1FY22 were Rs 4,190 crore, a 37% growth against a low base in Q1FY22 due to the national lockdown. Hydrocarbon revenues grew by 11% over a two-year period. This growth in revenues was because of the company’s strong execution of orders received in Q3 and Q4. In Q4FY21, the company received three orders from domestic oil and gas companies including ONGC worth Rs 150 crore. The segment’s EBITDA surged 2.4X YoY to Rs 402 crore in Q1FY22.

The hydrocarbon segment contributed 22% of pre-Covid revenues, but in Q1FY22, the segment’s revenue contribution jumped to 32%. The company expects a strong pipeline for hydrocarbon orders for the rest of FY22, perking up the company’s prospects and brokerage’s expectations. 

Hyderabad metro project still burns cash, L&T looking to sell stake

The Hyderabad metro project which L&T completed in 2017 still remains a misstep for the company and a drag on its cash balance. Due to the second wave, the Telangana government-imposed partial lockdowns and night curfews. This curtailed metro timings to six hours a day, leading to a decrease in footfall, and reducing L&T’s revenues from the metro project.

In Q1FY22, footfalls were 55,000 commuters per day, down 70% from the pre-second wave levels of 1.86 lakh commuters per day in February 2021. In FY21, the average ridership per day was close to 1.3 lakh commuters, peaking only during the end of the year. Ridership remained 55% below pre-Covid levels of 4 lakh passengers per day, and 73% below L&T’s expectations of 7 lakh passengers a day when it constructed the metro. During the Q1FY22 earnings call, the company said ridership in July doubled to 1.2 lakh passengers a day. However, ridership remains 35% below pre-second wave levels.

Even with a ridership of 1.8 lakh commuters per day in Q3FY21 and Q4FY21, L&T spent Rs 4,500 crore and made a loss of Rs 900 crore per quarter on the metro project. This grim situation worsened with the second wave. The metro project recorded a loss of Rs 400 crore on the project in Q1FY22 and expects the loss to widen to Rs 1,500 crore by the end of FY22. L&T allocated Rs 500 crore in Q1FY22 as cash support for the project, but this won’t be enough given the burn rate.

The metro project is already burning a hole in the company’s cash reserves, with brokerages expecting negative free cash flows of Rs 1,800 crore in FY22 and negative Rs 12,900 crore in FY23. This is because ridership is expected to remain below pre-Covid levels (4 lakh commuters per day) for the rest of FY22.

L&T is in talks with the Telangana government to divest part of its stake in the metro project, and also seek refinancing options to raise funds. The company has also been looking to sell its 1,400-megawatt thermal power plant in Rajpura, Punjab for Rs 9,690 crore to the Punjab government since Q2FY21. Raising external debt will be difficult for the company because L&T’s debt levels were Rs 22,800 crore at the end of FY21, said brokerages.

Hydrocarbon orders are expected to continue their momentum, as oil and gas, fertilizer, and chemical companies raise capex in FY22. But the key drag remains the Hyderabad project which is forcing L&T to raise funds by selling assets. 

L&T is a play on India’s infrastructural growth as the government plans to increase its capex as part of Budget 2021, and the company is set to ride that wave. However, investors should keep an eye out for L&T’s completed and cash burning assets (like the Hyderabad metro project).