In a quarter touted to be a seasonally strong one for construction companies in India, Larsen & Toubro cashed in. The company’s infrastructure segment order inflow was Rs 45,079 crore, up 40% YoY in Q4FY22. L&T bagged several new projects during the quarter despite state government sluggishness in awarding final approvals. Moreover, the construction behemoth managed to deliver on the revenue growth guidance set for its core business for  FY22. 

And now it has its eyes firmly on the future. At the consolidated level, the company is targeting a 15% CAGR revenue growth over the course of the next four years. While the company expects core projects and manufacturing business to grow at 14-15% CAGR, it expects the IT services revenue to double by FY26. 

The first move in this direction is the long pending merger of its IT services subsidiaries–L&T Infotech and MindTree. The idea is to extract material synergies in terms of scale of operations, reduced operating costs and better bargaining power to win large deals through this merger. 

The new merged IT services company will be called LTIMindtree. However, analysts are apprehensive of this integration owing to cultural differences between the two companies. 

Order inflow in core segment breaks records in in Q4FY22

L&T won projects worth Rs 61,337 crore, up 55% YoY, in Q4FY22. This is despite the fact that the state government moved slowly in awarding final projects during the quarter. According to the management, this was seen in the massive fall in award-to-tender ratio to 51% in Q4FY22, from 75% in Q4FY21. In fact, the award to tender ratio was down 19 percentage points on a full-year basis (51%) in FY22. 

One of the key reasons for this tepid trend in finalisation of project awards is cost overruns. Commodity price inflation in inputs like cement, steel, copper and aluminium led to escalation in project costs. Hence, the state governments are either renegotiating some deals with L&T, or reworking the project report to estimate the new project cost figure. This is causing the delays in the final clearance of projects.

But then, what led to the massive jump in L&T’s order inflows for Q4FY22? 

According to the management, strong traction in international projects (especially from the Gulf nations) boosted order inflows in Q4. Gulf nations are stepping up  investments in infrastructure and onshore oil projects as crude oil is on an upward trajectory since February 2022. Notably, L&T’s new order inflows in the hydrocarbons segment jumped 2X to Rs 7,390 crore. The company also won key orders for metro, expressway, health and public spaces projects within the infrastructure segment in Q4FY22. 

The defense engineering segment also saw robust order inflows in Q4FY22 helped by the Centre's indigenisation drive. While the annual order inflows for hydrocarbons segment were up 75%+ to Rs 30,880 crore, project wins in defense rose 4.4X to Rs 7,720 crore. 

L&T’s order book grew 9.2% YoY to Rs 3,57,600 crore in Q4FY22, despite the domestic segment being flat on a YoY basis. The share of the international segment in the overall order book rose to 27% in Q4FY22 from 21% in Q4FY22. 

Higher commodity costs hit core segment margins

The flagship segment of L&T –  infrastructure – saw a double-digit rise in Q4 revenues to Rs 29,727 crore backed by healthy execution. However, the revenues for hydrocarbons segment fell 3% YoY to Rs 5,237 crore as supply chain disruptions impeded the pace of project execution. 

Of the smaller sub-segments, the power division outshone others and posted over 20% YoY revenue growth in Q4FY22 while revenues for the heavy engineering segment fell due to delay in order receipts. 

Although core segment topline growth was encouraging, margin contraction led to a fall in its EBITDA in Q4FY22. And it was not just inflationary pressures that hit the operating income, non-certification of claims by clients also added to the company’s woes. These are claims that L&T presented for project cost escalations that were not approved by clients for some of its orders. 

The impact of a spike in commodity costs hurt FY222 results as a whole. While revenues for L&T’s core business rose 15% YoY to Rs 1,07,927 crore, EBITDA grew only 6% YoY to Rs 9,970 crore.

L&T bets big on green energy and data centres over the medium-term

As a part of its Lakshya 2026, L&T plans to invest Rs 1,000 crore in green hydrogen technology over the next five years. Green hydrogen is basically a clean fuel produced by splitting water into hydrogen and oxygen through the process of electrolysis, using renewable energy sources like solar/wind power.

The construction major is seeing lower demand for its turnkey solutions, boilers and turbines that it builds for coal-based power plants. It also noted in its FY21 annual report that push for renewable energy will ultimately dampen the demand for thermal power in the future. This is the key reason that the company is investing in the green hydrogen space. 

L&T will primarily invest in setting up an electrolyser capacity of 500 MW by 2026 which will be scaled-up to 1 GW by 2028. According to the management, green hydrogen technology has a huge potential to reduce India’s reliance on crude in the future provided it costs around $1/kg ($6-7/kg currently). However, L&T is not exactly the first mover in this space. 

Back in January 2022, Reliance Industries committed to invest a massive $75 billion i.e. Rs 5.5 lakh crore in green energy infrastructure to become carbon neutral by 2035. It will be manufacturing solar photovoltaic modules, advanced energy storage batteries and electrolysers etc. under this plan. Analysts estimate that the company would set up a 2.5 GW electrolyser plant for a start. The Adani Group is also a competitor as it committed investments of $70 billion in renewable energy infrastructure, including in green hydrogen back in November 2021. L&T’s investment plan clearly falls short of these existing commitments by other business groups. 

L&T also plans to undertake green hydrogen developmental projects on a build-own-operate basis for Indian Oil Corp. However, the green energy division, comprising the above projects, will contribute only 1% to L&T’s revenue in FY26 i.e., roughly Rs 2,740 crore. 

The other major bet for L&T is the data center and platform businesses. The construction major intends to set up data centres with a capacity of 90 MW by FY26. However, even in this space there are players like NTT, Nxtra by Bharti Airtel, and Sify already present in India. 

In fact, Nxtra by Airtel plans to invest Rs 5,000 crore for building new Hyperscale data centres in the metros. Then there are listed real estate behemoths like DLF also capitalising on the potential growth in this space. With multiple players entering into the data centre business, gaining bigger customers could get difficult for L&T. 

On the platform business front, L&T is looking to scale-up its EduTech (e-learning) and SuFin (B2B marketplace) platforms over the medium-term. These two particular businesses will become a part of L&T’s IT services segment. L&T is also aiming to raise the share of margin-accretive IT services segment in the consolidated  revenue pie to 27% by FY26. On the whole, L&T will invest around Rs 6,000-7,000 crore on these new business ventures. 

While L&T’s new businesses are well-intentioned, these are only baby steps in terms of the magnitude of investments planned. It will take a long time before these command a formidable share in the revenue pie. 

For its core business, L&T sees order prospects of Rs 8.53 lakh crore in FY23, down 6% YoY, as it adopts a more selective approach. The revenue growth pace (12-15% YoY) and EBITDA margins (9.5%) will be on the same lines as seen in FY22. Investors will be hoping all these plans bear fruit. Execution in the face of competition will be a key to watch out for.