Why analysts are angry with L&T

The international strategy of Larsen & Toubro, the country’s largest engineering and construction company, hasn’t quite worked the way it had wanted. It hydrocarbon division reported a Rs 900 crore loss in the June quarter. With the company booking losses in all the six hydrocarbon orders it won and implemented over the past three years, the stock has fallen 12 per cent since the results were announced. Analysts are angry, as the company’s performance is not in line with their projections and say L&T did not adequately disclose the extent of stress in its international order book.

They also say it has become difficult to rate the stock as the projection of earnings estimates is difficult, going by the frequent changes in financial reporting style, inadequate disclosures on stress in the international order book and confusing forecasts. The Street also believes the company has been chasing revenue growth at the expense of profitability.

While conceding the company underestimated the risks while bidding for international orders, R Shankar Raman, the group’s chief financial officer, defended it against all the allegations (see interview).

However, the market thinks otherwise. While L&T says it has learnt its lessons in the hydrocarbon space and bid for contracts as a consortium in the infrastructure segment, analysts believe the losses in its subsidiaries suggest the company might have repeated the same mistake in the latter segment. Espirito Santo Securities says: “Several other subsidiaries engaged in overseas markets have also seen sharp profitability erosions in FY14. This especially holds true for the key engineering and construction subsidiaries (L&T Electromech, L&T Oman, L&T Saudi Arabia, etc), which cumulatively posted a net loss of Rs 150 crore in FY14 (versus Rs 30-110 crore net profit over 2008-2013.”

Of the Rs 32,000 crore international order book in the infra segment, analysts believe at risk are road projects worth Rs 6,000 crore and the two metro rail projects (Riyadh Metro and Doha Metro). So far, L&T has not been present in these segments and analysts believe the the company followed an aggressive entry pricing strategy to gain a foothold.

Shankar Raman believes the existing foreign hydrocarbon book (Rs 10,000 crore) and infra order book (Rs 32,000 crore) are not at risk. He says: “If executed to schedule, we believe the present international order book in the infrastructure segment is profitable.” Analysts believe, given the geopolitical risks in the region, time overruns could be a risk even if cost overruns are not.

The other issue with most analysts is the allegedly frequent changes in reporting and inadequate disclosures by the company on stress emanating from international orders. Analysts charge the company frequently includes segments in the standalone business and then remove these, making year-on-year comparison difficult. While the company claims the comparable numbers were given for hydrocarbons, several other businesses have been added and later removed, leaving analysts confused. There are 138 firms functioning under the parent and tracking all of these and estimating the value of the standalone lot has become a bigger challenge of late.

Commenting on the issue of a trust deficit, Shankar Raman says in the interview he is surprised that the company’s open approach is “backfiring on us”.

While conceding that the move to consolidated reporting was needed, analysts say the nature of the forecasts (‘guidance’) has made it difficult to come up with projections and forecasts. While the company’s revenue guidance is at a consolidated level, including the services businesses, the margin guidance excludes the services segment. Also, over the past couple of years, the company has moved several segments out of the standalone business and added others, making year-on-year comparison difficult even at the standalone level. Given poor performance in the Gulf, analysts say they are uncomfortable with L&T’s international order book. This year’s order guidance is also expected to be driven by five large international orders.

What has angered analysts the most is that the company did not in any way prepare the market for a Rs 900 crore loss. While L&T says it had mentioned there were cost and time overruns in some international projects, the market says the company had never indicated that all the six hydrocarbon projects were implemented at a loss. They will keenly watch the performance of L&T’s subsidiaries abroad to monitor signs of stress. While the company might meet its order inflow guidance for FY15, the revenue guidance could be at risk if the domestic capital expenditure cycle does not pick up.