Engineering major Larsen & Toubro (L&T) made two major announcements on May 10 — its financial result for the fourth quarter of 2023-24 and the transition in leadership. The company’s Chief Financial Officer R Shankar Raman spoke exclusively with Moneycontrol to share how the leadership change is expected to be seamless and how the company is on track to achieve the goals set up in its five-year strategic plan, Lakshya’26.
Raman said that the company is guarded about its prospects in India in the current fiscal, given the likelihood of the upcoming election disrupting the project ordering and execution process. He said that L&T is looking at an order pipeline worth Rs 10 lakh crore and hopes to maintain a winning rate of 15-20 percent. Edited excerpts:
L&T reported 17 percent growth in revenue, 12 percent in profit and 19 percent in order inflow in FY23. While the company met its guidance on revenue and order inflow growth, it missed on margins, which shrank from a year ago. How did FY23 pan out and what led to the shrinking of margin?
Thank you for raising this because this has been bothering a lot of people as to whether the company is under stress insofar as margin accrual is concerned. I think it's important to understand the breakup of this because much of the revenue that we have reported, Rs 1,83,000 crore is the portion that comes from the project business that has been executing jobs that we have won in FY21 and FY22. And these were unique periods in the sense that the jobs were given but costs at which we were to procure material and equipment actually skyrocketed. And also, these were given at a time when the post-COVID recovery was not really complete. There were interruptions, both in terms of supply chain, shipping goods, labour availability of the kind that is required to execute the project, the client's preparedness to open up his own facilities for us to execute the project... So the first casualty in all of this was time. We lost close to a year waiting for things to return to normalcy so that we could work to our plan. Kindly enough, the clients quickly agreed on time extensions.
So we avoided the prospect of any liquidated damages that could have harmed our P&L (profit and loss account). But what we had to do was to maintain the site as mobilised, in fact, invest a little more, making sure it is safe and a secure environment for people to stay and wait for necessary clearances. Consequently, the additional cost that we incurred is embedded in this margin erosion.
The second part of it is when the sites became available for us to work, we had to actually place orders and start procuring goods and equipment to complete the projects. By then, I think COVID became a worldwide phenomenon, and to complement this, the war also broke out in Europe, which actually threw the supply chain out of gear. And even if the vendors were ready, the shipping lines were not available. And there were a whole host of logistics issues that actually delayed the receipt of material. Meanwhile, prices kept going up, in fact, to an extent where 25-75 percent was the order of magnitude in the case of some underlying material or equipment that were dependent on them.
We have to deal with all of this. The ultimate objective of the company was to make sure that we deliver to the revised timeline that the client has agreed to. That meant that we had to catch up on execution, which is what is evident in FY23. As against the guidance of 12-15 percent, we actually ended the year with a revenue growth of 17 percent. And these percentages are on large bases. So I think that is reflective of the fact that we put more resources to make up for the lost time. Much of the cost we have accounted for in FY23 is the result of this inflationary input cost. We do think that the orders that we won in FY23, which is almost Rs 2,30,000 crore, have been procured on better terms. And in any case, the environment on supply chains is far more predictable today compared to 2021 and 2022. The softening of materials prices has been what was behind people expecting our margins to be met. But the softening of the materials price has happened in the last six months. And what we have reported in our numbers are not necessarily what we have committed to procure in the last six months. These are commitments and procurements made over the past years.
The projects need to be completed. I believe that it will take possibly two or three more quarters for all of these commitments to get completed for us to sit across with the client and start discussing price variations. Contractually, there are many contracts which have this permitted as a price variation formula. We need to translate this into actual numbers, support them with data and make our respective claims. But this is an ongoing process in the projects business. This will happen over a period of 12 months after the project gets completed. So you will see the softness of the margin that we have reported in FY23 play out definitely during the first half of the current year as well, FY24. The trajectory will change as we complete our past commitments during Q3 or Q4 of FY24. So I see 2024-25 to be a more normalised year where the margins with which we bid for a project are close to being achieved. Of course, I'm making a big prediction that nothing destabilising or a black swan event will happen in 2024-25. But keeping that aside, I think that the worst in terms of absorbing the cost for past obligations is by and large done with.
You have given a revenue growth guidance of 12-15 percent and an order intake growth guidance of 10-12 percent in 2023-24. Are you being conservative or do you see challenges in the current fiscal year?
There are two different dynamics. Orders, we have a very large base. I mean Rs 2, 30,000 crore, and anything to grow on that by very strong numbers is a function of how investments happen in the system around us. I think that will drive the actual outcome as to how much we make. But based on the pipeline that we have and our own assessment that we make every now and then of what is likely to materialise, what is not, we think 10-12 percent seems to be a reasonable bet. I have also taken into account in this guidance that this year could be a little lower than the 12-month period because of the election. We do not know. The dates are not yet announced.
But it is quite prudent to assume that we may not have the entire 12-month calendar to walk through this year for our plans. It could get truncated depending on the election situation. Because in the run-up to the election, there are periods where I think the priorities of the government change. And consequently, the thrust that has been given over the last 12 to 18 months or even 24 months about ramping up, scaling of projects, awarding more, etc., could take a bit of a breather. That is inbuilt into our assessment. If none of those happens and the election really is announced in 2024-25 and it doesn't affect up to March 2024, maybe then the upsides could exist, but we don't know now.
Secondly, as far as revenue is concerned, for the same reason of it being an election period, the disruptions that could happen, etc. We have factored in the possibility of a little bit of a truncated year. And as I mentioned to you, the execution of the orders that we won in 2023 will actually happen after about 12 months. The first six to nine months will go into engineering work, approvals and clearances. Then, the next couple of months will go on procurement, order placement, negotiating with vendors, etc. The actual work on the field will happen in the following year. So for 2023 order wins, 2024-25 would be the year where you will see execution on the ground, and hence margin accruals. During the engineering and all that procurement, there are no margins that really accrue. The cost gets accumulated but margins don't accrue. And by then hopefully, the backlog that I have today of Rs 4 lakh crore, which is Rs 2.31 crore of current wins and about Rs 1.7 lakh of the past wins — this Rs 1.7 lakh will get washed through the period largely of 2024 and partly of 2025. What is remaining is the tail portion of the old contracts, which is why I feel the first two-three quarters, if the margins are soft, they're soft for a reason. And the recovery of margins from Q4 of the current year into the following year could possibly get us back to more normal times.
L&T derived a majority of its orders from government-backed projects. Against the backdrop of the upcoming election and the possibility of slowing of government orders, what is your expectation from the private sector? Are we seeing a pickup in capex and what are the sectors which you think might be driving growth this financial year?
Interesting that you speak about it, because statistically, in FY22 we had of the incremental orders that we won in FY22, we had 26 percent or thereabouts from the private sector. And when I talk about the private sector, I am geography-neutral. I mean, whether it is India or overseas, putting it all together. That number moved up to 32 percent in FY23. So the year that we just reported, 32 percent of the projects in the manufacturing business had private sector orders and it's only 68 percent had the government as a sponsor, whether it's state, Centre or PSUs. Where has this movement happened? I think one place where the movement has happened is in the area of steel and metals, basically metals, because I think the pricing power the market seems to have appreciated and they're investing in capacity. So we won a fair bit of orders in our minerals and metals business.
The second bit is all the airport orders and the station redevelopment orders, etc., they're all maybe government-enabled, but executed by the private sector, the concessionaires are from the private sector. So that's the second piece that has moved.
The third piece that has moved is the automobile industry in this transition of normal vehicles to EV (electric vehicle) and stuff like that. A lot of additional add-on investments for additional lines have come in from this sector. And since we have been building automobile plants, etc., we have also benefited from that. The ancillary industry associated with automobiles, the tyre-making machinery, etc., have also seen a lot of pickup and we find orders for tyre manufacturing equipment and businesses pick up. Given the activity that is generally there in the infrastructure space, the construction and mining equipment business has picked up. And there're also orders from that sector. For example, we received large orders from groups like the Tatas, Jindals, etc., which significantly pushed up the ratio for that vertical for private sector orders.
Then, we look at the whole space of energy transition. The investments that the private sector is making — and this you could attribute to possibly the ESG (environment, social and governance) thrust or the general awareness about wanting to be more climate-friendly, and hence more sustaining—is making people invest in zero water discharge or in effluent treatment or even renewable energy. These are all happening within the private sector space. That’s not to say the public sector is not interested in this. For example, IOC (Indian Oil Corporation) is making big moves on green energy. But those are yet to hit the order book. But private sector orders are much smaller and they are quicker.
Then finally, the whole space of data centres and healthcare systems. These are two areas where the private sector is investing. Hospitals are being built, data centres are being built. The whole issue around data privacy and localisation of data, etc., is also making the IT companies pack services on top of the data centres that are being built. And India being the IT powerhouse it becomes a natural space for hyperscalers to look at.
Commercial real estate is another area for the private sector. And we do think with some amount of momentum picking up on the return to working from office, this will get rejigged. Companies are now beginning to create capacities in Tier 2 towns. Earlier, everybody was focusing on Tier 1 because that is where talent was supposedly available. Today, talent has migrated from Tier 1 to Tier 2. So you have to have enabling infrastructure in Tier 2 towns. That is also being done by the private sector. So I see while there is no wholesale jump in private sector capex, incrementally, based on the sectors that are engaged in growth, these investments are happening and I think this will gather pace. We need to be a little more patient because the private sector balance sheet after a lot of effort has been cleaned up. I don't think they will forget the lessons in a hurry. And they won't go on a big binge on investing in capacities without being sure of the returns that they generate.
L&T undertakes a massive exercise at the beginning of every fiscal year to assess opportunities. What is the order pipeline looking like for FY23-24 in the domestic market as well as the international market? What is the pipeline? In a good-case scenario, how much of these orders can you win?
We normally look at the pipeline from the perspective of what interests L&T. So the bigger outlier of what is happening in the overall economy is something that I'm keeping out of this limited conversation. When we looked at what could interest us, the pipeline seemed to suggest something like Rs 10 lakh crore as projects that are likely to come through. Now, these are sectors where we are deeply involved in. Out of this Rs 10 lakh crore, you can say roughly 35 percent would be international, 65 percent domestic. Let me break this down a little more for you. Of this Rs 10 lakh crore, about Rs 6.5 lakh crore is what we assess broadly, I am just rounding off on a ballpark basis. Rs 6.5 lakh crore would be for the infrastructure sector and this would be across buildings and factories, power transmission, transportation infra, heavy civil, minerals, metals — all of that put together. We think the energy space led by hydrocarbons would see about Rs 2.5 lakh crore. This will be both onshore and offshore investments. We expect maybe 60 percent of this to happen in the international markets and only about 40 percent in the domestic market.
Given the demand for power and the need for the government, particularly in an election year, to ensure power availability, we think there will be one or two opportunities in traditional coal-fed or gas-fed power plants. Limited opportunities for us, given that BHEL (Bharat Heavy Electricals Ltd) is a very large competitor. But possibly put together, about Rs 30,000-50,000 crore worth of opportunities could exist including the desulfurisation campaign, where all the old rundown power plants are getting refurbished to reduce emissions and pollutants. Between the rest of the businesses we run, it could be another Rs 2 lakh crore. So, put together, this Rs 10 lakh crore is what we look at. Normally, when we do this exercise and actually look back and see how we have fared against this pipeline, our win rate has been between 15 percent and 20 percent.
So, we think out of this Rs 10 lakh crore, about Rs 2 lakh crore could be what could come our way. Now, this obviously excludes the growth in the services business collectively between the IT companies. We are today about $5 billion. We expect to keep the momentum in that sector at 15 percent growth year-on-year, and in a good year, it could go to 20-22 percent as had happened in 2023. In 2023, we reported almost a 27 percent growth. But if you even normalise it to 20 percent, averaging between 15 percent and 27 percent, that could keep us engaged as well. So, on top of the Rs 2,31,000 crore that we have done, we see about Rs 2,60,000-2,65,000 crore as potential wins. And that adds up to this 10-12 percent guidance we have given.
L&T has a stated strategy to increase the share of IT and services to its total business. In this business, at a micro level, you have seen some high-level exits after the merger of L&T Infotech and Mindtree. On a macro level, global IT majors are being cautious about the demand outlook. Given these two challenges, what’s your strategy to achieve the target of 15-20 percent growth?
See, exits seem to be a way of life for the IT world. I very rarely see that the same team continues for a long period of time. By contrast, at L&T, you will have people working for 25, 30, 35 years quite easily. You don't get that kind of profile in IT. So in IT, our orientation should be to get the right skill pool for a certain project or a set of projects that we are working on and making sure there is no exit midway to create disruption in that project. Secondly, the integration that we attempted between Mindtree and LTI has gone on rather smoothly. If you consider a total resource pool of 95,000 people between these two companies, I think the exits that have happened have been a very small number. This is something that we were anticipating, but happy to report that the outcome has been far better than what could have been our worst-case scenario in such a situation.
As far as growth is concerned, I think all the big players—and we consider ourselves fairly small, I mean, $5 billion at the end of the year, there are companies which do this in one quarter—their assessment of opportunities and delta growth is like our infrastructure growth. Since the base is so large, they think to grow at 20 percent is a huge task. So these IT companies are possibly having scale as an issue when it comes to delta percentages. L&T Infotech and Mindtree combined, being that much smaller and operating in a more nimble fashion at another level of client engagement, we think that this level of clients have not pushed back on their programmes. In fact, whatever business model transition programmes that they were working on, they have to complete. They can't abandon it midway. What is under question is, how much of discretionary spend will they commit themselves to going forward? Our sense is that given our base, we see clients possibly remaining engaged with us for this growth that we are talking about. But at the moment, we are too small to really put out a caution, saying that growth has become a concern for us. I think we need to make sure that the opportunities that do not go to the large companies, because of whatever filters that they have, we're able to grab and make inroads in those accounts.
The other big announcement from L&T is the change in leadership with AM Naik stepping down from the position of non-executive chairman, after 58 years with the company. This change is happening at a time when L&T has embarked on its most ambitious strategic five-year plan thus far — Lakshya '26– which aims to double revenue and order inflow in five years by 2025-26. The plan also includes exiting non-core operations and expansion of the services business. How is it going and what challenges do you foresee?
This transition couldn't have been as seamless as it has actually been. I think one of us has actually taken on the larger responsibility. You approach it as one of our colleagues having gotten to this important position, and Mr Naik's shoes are huge to fill. That, I think, everybody concedes. Evaluating how successful the transition has been will not be so focused on as it would have been in the case of some external third party coming in and assuming leadership. Here, I think it is just the question of continuing the momentum. Mr Naik has provided us with a fantastic base and we couldn't have asked for more. I think it will be our collective job to make sure that we are able to support the vision and the plans of the new leadership, and make sure we take the company forward, so that we can possibly do to our successes what Mr Naik has done to us. To that extent, I think this transition was very well-planned and has been smoothly executed.
Now, coming to the question of Lakshya, I think it was ambitious in 2021 when we were just off COVID. We still set ourselves a target of doubling the order inflow, doubling the revenue and, most importantly, doubling the ROE (return on equity). We were at 9 percent ROE. We said we'll go to 18 percent ROE. All this meant that we have to do things that make our costs competitive, make our technology futuristic, be able to be relevant to the client in terms of execution and be profitable. And all of this has to be done. The levers for all of this would be to make sure that, are very efficient when it comes to resource utilisation, be it men, be it machines, be it money. I think we need to be extremely careful about how we use our resources. Two, we have to take advantage of the fast-evolving technology to be able to improve our productivity. Again, the fact that today we can track most of the things that people or machines do enables us to possibly take calls on optimising the use of resources. And that is something that we should continue to press on, because I think we are just still nibbling at the tip of the iceberg in terms of what potentially we can do to transform the company.
Third, we have already completed two years of the Lakshya plan and we are actually bang-on in terms of the path so far. The challenge would come in possibly the last two years of the plan, where like the slog overs in T20 the asking rate creeps up. I think we are a year away from having to sort of ascend that final peak, which we are confident that if we continue to work the way we did in 2023 and continue to do things to improve the margin profile then we should be able to get there. As far as ROE is concerned, I think it's also a function of a) completing the divestments so that the losses that we were booking in our books on account of these infrastructure investments disappear. And, b) make sure, as I spoke to you earlier, the normalcy returns to our core business.
Three, scale up our services business, which is the most profitable piece of the portfolio that we run. And fourth is to make sure that the extra cash that we have, we are able to share it with the shareholders. The recent dividend declaration of Rs 24 per share has a 43 percent payout ratio. L&T normally has been paying out at 25-30 percent. It has not been paying out 40 percent and thereabouts. We'll continue to do this. We are not looking at the Lakshya period for any big-bang investments. In terms of acquisition, there would be tuck-in acquisitions, etc., that will happen in the services space, that will continue. But services businesses are run in a separate listed company's balance sheet. So I don't think L&T's core shareholders need to worry about that. L&T's own growth plans involve normal investment in capex, maybe some investments in this green energy transition and data centre. But beyond that, we don't have much debt to service. So if we are able to conclude our Lakshya plan well, I think there's a good opportunity for us to share our fortunes with shareholders.
Would you like to put a number on the capex that you're planning?
About Rs 4,000 crore is what we normally set aside annually for capital expenditure on strategic equipment. Maybe another couple of thousand crores for this green energy transition and maybe a couple of thousand crores for the data centre that we are working on. So, put together, on the cash that we generate on a year-to-year basis, something like Rs 13,000-14,000 crore. If our working capital is managed as efficiently as we have done so far, I see the debt servicing obligations being very limited, the annual capex can be conveniently met out of this, and there will be cash to spare.