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L&T: The sun also sets on the L&T empire - Outside View
 
 
L&T: The sun also sets on the L&T empire

A Bizarre Conglomerate

Larsen and Toubro must rank like no other Indian private sector conglomerate, for the sheer 'numbers' that contribute to its size. Besides the 8 major divisions that the company operates in, the group consists of 110 subsidiaries, 21 associate companies, and 12 joint ventures. Now, how is that for size? The business TV channels should seriously think of giving awards to companies for such seeming delinquency. For example, almost all the joint venture companies resemble a 'piggly wiggly' agglomeration at best. But, more on this matter later. One also wonders whether the CEO has a clue of the names of all the companies that comprise the group. And the CFO suo-moto appears to have created more work for his department, than he would have liked to anyway.

The big plus about this company though, is that it appears to have created very iron tight contracts for the innumerable projects that it has taken on board. The provision that it has created during the year in its P&L account, for the foreseeable losses on construction contracts, is a miniscule Rs 780 m. This provision is only slightly larger than the provision that it created in the preceding year.

Subsidiaries do not add up to much

The gross revenues of the standalone company stood in at Rs 394 bn. But the subsidiaries and affiliates, though they number in the many dozens, do not really add up to that much in terms of revenue and income generation. The additional revenue and income generation, from the subsidiaries, joint ventures and associates came to Rs 75 bn, after eliminating inter-company sales. That is to say, in a consolidated gross revenue of Rs 469 bn, the contribution of 'others' was 16% .But this is also the first company that I have looked at where the profitability ratio of the consolidated results was superior to that of the standalone company. The PBDIT (Profit before Interest, Depreciation and Tax) of the standalone company was 14.5% of the gross revenue. The PBDIT of the consolidated results was 15.3% of the gross revenue. That is saying something, alright.

The subsidiaries and affiliates operate in 9 sectors, ranging from IT, engineering and construction, power equipment manufacturing, power development, infrastructure, electrical and electronics, machinery, and, international investments. Their geographical spread outside the country ranges from the Middle East, Nigeria, China, Mauritius, Malaysia, Indonesia, Australia, and Iran. The Middle East is the company's biggest focus areas with a presence in 5 countries. The largest single country focus is China with 4 manufacturing companies and 1 trading company. This is followed by Oman and UAE with 4 companies each. The company's investments in its overseas subsidiaries are largely routed through its subsidiary investment company, L&T International, based at Sharjah.

The equity conundrum

There are several standout aspects of this company. The most striking is its paid up equity. On a gross turnover including other income of Rs 394 bn, its paid up equity is a mere Rs 1.2 bn, excluding the employees' stock application money of Rs 250 m. In other words, the turnover is 328 times the paid up equity. (Technically there is no sweat in having an equity base which is totally out of sync with a company's turnover. MRF the tyre giant recorded a turnover of Rs 56.5 bn on a paid up equity of just Rs 42 m for the latest accounting year! However, in equity investing, one of the yardsticks used to measure a company, is to evaluate the turnover relative to the paid up equity. That is to say the gross revenues should ideally range in the region of 20 times the paid up equity. The reckoning being that the EPS gets skewed if the paid up equity is too high relative to turnover, as was the case with Whirlpool, or vice versa, as in the case of L&T).

The paid up equity of L&T would have been a lot smaller than even this figure, but for its promarket technocrat Gujarati CEO, Mr. A M Naik. After his ascension to the corner office not many moons ago, he has already rewarded shareholders with two 1:1 bonus issue offerings. That was how tiny the paid up equity base was, prior to his holding the umbrella. On the other hand the reserves and surplus currently is a more than a gargantuan Rs 179 bn. Since the company has no promoter issue concerns, (the financial institutions being the biggest shareholders), it oftentimes issues shares at a hefty premium to fund expansion schemes. Consequently the securities premium reserve alone in the overall reserves scenario stands at a hefty Rs 64 bn. The news is that Mr.Naik is due to hang up his boots in 2012, when he reaches the mandatory retirement age of 70. Almost certainly he will ring out his career with another magnanimous bonus issue offering.

The excise duty element

The second standout is the amount of excise duty that it pays. At Rs 3.2 bn it works out to less than 1% of the turnover. This is a bit surprising as sales of manufactured items at Rs 118 bn, accounts for a little more than 30% of gross sales. The company makes and sells myriad items ranging plant and machinery for a variety of industrial sectors, to switchgears, to nuclear purpose equipment, to electronic control panels, and god only knows what else. If this sounds impressive, compare that to what it can make on paper. According to the schedule for capacities and production, it can make some 36 different product items. It is another matter that it does not produce 16 of them for whatever reason. Why it chooses not to do so is not readily available. In manufactured sales, the income generated by industrial 'plant and machinery' accounts for close to 50% of the total revenue generation.

The sales classification

The next standout is the way it classifies its sales. By its own admission it operates in 8 major divisions headed by the senior most executives. Seven of these divisions are headed by whole-time directors of the company. But for corporate reporting purposes, the cumulative sales of these divisions are compressed into groups in the schedules. Why the company has chosen to do so is not known, as each division is definitely a profit centre. And, different schedules have different group classifications. In one schedule the gross revenue is classified under 5 subheads. In this schedule, the subhead under 'Construction and Project Related Activity' accounts for 85% of all revenues. The subhead under 'Manufacturing and Property Development' accounts for a further 14%. The two together round out the picture. In the 'business segment' schedule, it is again classified differently. Here the revenue generation is under 4 groupings, with the fourth group going by the nomenclature of 'Others'. By far the largest group in this latter classification is 'Engineering and Construction' which hogs close to 86% of all revenues. The 'Electrical and Electronics' group accounts for another 8% of turnover. A smaller number of group classifications imply lesser revelations. It thus increases the company's ability to hide inconvenient disclosures perhaps, of the not so competent divisions. It is as simple as that. And, besides, it is also a neat way of abiding by the rules of the game.

The finance puzzle

Another big standout is the way the company manage its finances. It believes in keeping the debt tap open, and then investing this dough frantically, and in all directions. Chaos management appears to be its chosen financial management philosophy. (What eased the pressure on its finances immensely during the year was the windfall income that it earned from the
The financial demands on the company were infinitely higher in FY10 than in the preceding year. To meet the additional demands, it generated cash of Rs 55 bn from operations, which was 3.7 times more than in the preceding year. The single biggest trick that it resorted to here to generate more cash, was to limit the increase in trade receivables, and get substantially more accommodation from trade creditors.

Investments and subsidiaries

The investments in its subsidiaries yield only a few dimes as dividends, given the scale of the investments. Add to it the cost of paper required in the annual report to list out its holdings in securities. The list of holdings in subsidiaries, associates and liquid securities etc, alone runs into 9 long pages! The annual report in itself runs into 234 pages. Then there are the advances that it has made to its subsidiaries under various counts, including loans, and inter-corporate deposits, which total a further Rs 25 bn. However, by and large, the functional subsidiaries appear to be stand alone units, given the meager inter-se dealings with the parent, on both revenue and capital account.

It is also fair to assume that the finance and treasury departments together host a sizeable number of employees. The company is also definitely not a low wage island by any reckoning judging from its employee handouts. Purely by making an extrapolation from the data available in the annual report, the average handout per employee including all benefits would have on a rough basis worked out to Rs 6.25 lakhs.

Last but not the least is its many subsidiaries. The company has furnished the brief working results of all the 110 subsidiaries, including those which have not gone beyond the incorporation stage. At the rate at which L&T germinates them, one only shudders to think what the next year's annual report will reveal on this score. The operational details of its subsidiaries itself runs into a neat 7 pages. Fully 52 companies out of the 110 have yet to turn the bottom-line corner, and in several instances have no turnover to start with. Of this list of subsidiaries, the most startling results pertains to L&T Infrastructure Development Projects which has total assets of Rs 19.3 bn, and a turnover of Rs 60 m, but recorded a phenomenal profit before tax of Rs 6.4 bn. This type of profit churning is even more incredulous than the great Indian rope trick!

Turnover wise, the 3 largest companies appear to be Larsen and Toubro Infotech which clocked in sales of Rs 17.8 bn, Larsen and Toubro (Oman) with a turnover of Rs 15.5 bn and L&T Finance with a turnover of Rs 9550 m. By God's grace all the three companies have reported healthy bottom lines. The Infotech subsidiary is actually surfing the internet highway in style, thank you. On a miniscule paid up equity of Rs 160 m, it recorded revenues of Rs 17.8 bn along with a pretax profit of Rs 3.2 bn to boot. Now one understands why it bid so aggressively for Satyam.

The way the market sees it

The stock market in its own wisdom looks only at the big picture. The fact that the parent is dotted with a population explosion of weird looking siblings is lost on market players. The way large construction companies are valued by the market, is in the additional contracts that it bags each year. The more it grabs in value terms, the more merrily the market discounts the company's earnings. L&T has proved more than adept in landing more and bigger contracts each year. With the very pointed governmental emphasis on infrastructure creation, the well entrenched company on paper, looks all set for even bigger news making in the years to come.

Disclosure: Please note that I am a shareholder of this company

This column "Cool Hand Luke" is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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Equitymaster requests your view! Post a comment on "L&T: The sun also sets on the L&T empire". Click here!

5 Responses to "L&T: The sun also sets on the L&T empire"

Jignesh Oza

Sep 14, 2010

Very informative artice. Thanks.

Like 

rk77

Sep 13, 2010

L&T stock continues to move up not withstanding criticism by many stock experts. It is a complex orgn and has a charismatic leader in Mr Naik. With no 2nd genration leadership visible the real danger is what will happen after he retires. The execution issues have been explained by Mr Naik as inherent to the industry and he seems confident to meet the guidance at the end of the year. Perhaps one should not write off L&T at this stage.

Like 

lini

Sep 13, 2010

fine article on one of the global giants!

Like 

H.S.Ponnuraj

Sep 9, 2010

Fascinating!

Like 

Ratnakar Gokhale

Sep 9, 2010


Fresh perspective.
If we look at any giant globla organisation. The description will be similar.

Cool Article indeed!!

Like 
  
Equitymaster requests your view! Post a comment on "L&T: The sun also sets on the L&T empire". Click here!
 

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