L&T’s big deal done, more to come: Analysts

Brokerages have raised their earnings estimates after the deal with Schneider, and believe core business performance will improve in coming quarters

For engineering conglomerate Larsen & Toubro (L&T), its biggest divestment deal with Schneider to sell the electrical and automation (E&A) business for ~140 billion marks the end of its non-core divestments, according to some company executives.

“At some point of time, if some asset gets matured and does not fit into the core, then we unlock the value and invest it further in something else. At present, after this transaction, we do not see anything going forward,” said S N Subrahmanyan, chief executive officer and managing director for L&T.

But, the Street believes, there is more ahead for L&T, both on the divestment front and due to expected improvement in its core business, given that spending on infrastructure projects is on the rise.

G Chokkalingam, founder and managing director, Equinomics Research and Advisory, says the divestment will lead to significant cash flows at a time when economic growth is expected to pick up.

Expected to be complete in 18 months, the deal will help L&T cut its core debt, excluding financial services and development projects, by almost half, which stood at ~208 billion as of December 2017, according to L&T's presentation.

Nonetheless, they see more divestments ahead. As part of L&T’s strategy to monetise assets, there is an infrastructure investment trust (InvIT) in the offing. In addition, there is an expectation of further action on the sale of its Rajpura power plant. “The Rajpura power plant could see some development towards second half of 2019-20,” IIFL analysts Renu Baid and Nayan Parakh wrote in a report on L&T. However, it may be challenging to find a buyer for the power asset in the current market where huge thermal power capacities lie stranded.

Sale of such assets will help further cut down debt, but at the consolidated level. As of March 2017, L&T had consolidated debts of ~939.76 billion. Though the group’s management on Tuesday did not share any plans for the utilisation of proceeds from the deal, the IIFL analysts added the proceeds could be used to deleverage and to make technology and manufacturing business acquisitions in defence and aerospace.

L&T is yet to complete and receive the full proceeds from its sale of Kattupalli port to Adani Ports and SEZ. Though undisclosed, sources pegged the value of this deal at ~22 billion.

The sale is part of L&T’s Lakshya programme where it plans to divest non-core assets, focus on its core business of construction and engineering, and enhance margins among other things over the next five years up to 2021.

Schneider deal: In-line valuations

Analysts at Motilal Oswal Securities said the deal was in line with L&T’s Lakshya programme and at ~140 billion the E&A segment was valued at 2.7x sales and 33x earnings based on FY18 estimates, and was largely in line with its listed peers such as Havells, ABB, and Siemens. The analysts added that the deal would be earnings accretive and they revised upwards their 2020-21 earnings estimates by 2 per cent each and the sum-of-parts-based price target to ~1,690.

Morgan Stanley, shared a similar view. “The L&T stock trades at 24x estimated EPS for 2018-19 based on consensus earnings. We view the deal positively from a sentiment perspective as it reiterates L&T's resolve in unlocking value while continuing to dominate the EPC space,” it said.

Core business gaining Even before this deal, analysts were positive on L&T due to its improving order execution and order flows. Edelweiss, for instance, expects a gradual, but broader recovery in the domestic market for L&T during the March quarter, as was seen in the first nine months of 2017-18, which saw core infrastructure execution growth of 15 per cent. Execution in the domestic engineering and construction (E&C) segment has also picked up post GST (goods and services tax) implementation in the third quarter of 2017-18 and analysts expect the momentum to continue in the March quarter. Motilal Oswal projects an order inflow of ~462 billion (flat year-on-year) in the March quarter, but builds in a 5, 10 and 14 per cent growth in L&T's order inflows for 2017-18, 201819 and 2019-20, respectively.

The L&T stock has been on an uptrend, outperforming the Sensex since December. Currently, at ~1,401.60, it is not far from its all-time high of ~1,469.60 seen in early February.