SUBSIDIARIES DRIVE L&T’S M-CAP

The m-cap of four listed arms is now equivalent to 82 per cent of the parent company’s valuation

The stock of Larsen & Toubro, India's largest infrastructure, construction and engineering company, made a new life-time high on Friday. It closed the day with gains of 2.8 per cent against 1 per cent rise in the benchmark Sensex.

The Mumbai-based company’s stock price is now up 30 per cent since the beginning of the current calendar year against a 16 per cent rally in the benchmark index. In all, the stock is up 107 per cent since the end of March last year against an 88 per cent rally in the Sensex.

This makes L&T one of the top-performing large-cap stocks in the pandemic period.

A deep dive into L&T numbers, however, suggests that its outperformance is being driven by its subsidiaries, rather than its core business of construction, engineering, and capital goods manufacturing.

This shows in the relative market capitalisation of L&T and its subsidiaries. L&T’S four listed subsidiaries combined market capitalisation of ~1.93 trillion is now equivalent to 82 per cent of L&T market capitalisation, up from 53 per cent at the end of March 2020 and just 20 per cent five years ago in August 2016.

In the past five years, while L&T mcap is up just 66 per cent, its subsidiaries' cap is up nearly 600 per cent.

L&T’S stake in the four listed subsidiaries is now worth ~1.36 trillion against the investment cost of around ~16,000 crore. This, analysts say, has boosted the equity value of L&T, resulting in a higher share price despite a poor showing by its core business. L&T also earns dividend income from its subsidiaries that boosts its bottom line. L&T holds 62 per cent to 75 per cent stake in its four listed subsidiaries.

The biggest growth driver for the company had been its IT and technology services business spread across three listed company. In comparison, the financial services business has been a laggard for a few years now.

The company’s IT and technology services business is housed in its three listed subsidiaries — L&T Infotech, L&T Technology Services, and Mindtree — that the company acquired in a hostile takeover in July 2019. The financial services business is housed under L&T Finance Holdings -- the first L&T subsidiary to list, way back in 2012.

These three IT and tech companies now have a combined market cap of nearly ~ 1.72 trillion equivalent to three-fourths of L&T own market cap. This makes L&T the country's fifthbiggest player in IT services space, in terms of market capitalisation ahead of Tech Mahindra and behind HCL Technologies. Tech Mahindra is, however, still 50 per cent bigger in terms of revenues.

The company's core business has almost stagnant for nearly five years and most of the incremental growth in the company's consolidated revenues and profits has been driven by its subsidiaries in sectors, such as IT services and financial services.

For example, excluding the contribution of its four listed subsidiaries, L&T would have reported a net loss of around ~60 crore in the June 2021 quarter (Q1FY22). It was the same in Q2FY20 — when ex-its subsidiaries — L&T would have reported a loss, a first in nearly a decade.

In FY21, the company IT & Technology services and financial services business together accounted for 42 per cent of L&T consolidated profit before interest & taxes (PBIT), up from 37.6 per cent in FY20 and 29 per cent three years ago in FY18.

For the first time in decades in FY21, the company's earnings from IT & technology services exceeded the profits from its core infrastructure and engineering business. The IT services business reported PBIT of ~4,823 crore in FY21, against the infrastructure division PBIT of ~4,521 crore last financial year.

Most analysts expect the trend to continue, given slowdown in capex and investment in India that drives L&T’S core business. The company has also been steadily selling off various parts of its manufacturing and engineering business and investing the proceeds in IT services and financial services.