Detailed Rationale

CRISIL Ratings has reaffirmed its ‘CRISIL AAA/Stable/CRISIL A1+’ ratings on the bank loan facilities of L&T Technology Services Limited (LTTS).

 

The ratings continue to reflect LTTS’s strong business risk profile supported by its established market position and diversified product offerings across various end-user industries. Company’s large client base in key markets has helped it in continued deal wins over the years. In the first six months of fiscal 2024, operating income grew by 9% year-on-year to Rs 4,688 crore with EBITDA margin moderating to 19.8% as compared to 22.2% in fiscal 2023 owing to broad-based growth across segments mainly transportation, industrial products and medical devices with inclusion of lower-margin Smart World & Communication (SWC) business acquired w.e.f. April-2023. LTTS continued to remain financial debt free with cash surplus of Rs 2,269 crore as of September-2023 after paying ~Rs 800 crore for SWC acquisition. Finance lease liabilities as of September-2023 stood at Rs 551 crore (Rs 454 crore as of March 31, 2023)

 

The niche presence in value-added segments and focus on emerging areas such as automotive (mainly Electric Vehicles), medical devices, telecom and 5G, process engineering, and industrial automation alongwith acquisitions will aid annual growth in revenue of 17.5-18.5% on constant currency basis in fiscal 2024 and 10-12% over the medium term. EBITDA margin is expected to range 20-21% in fiscal 2024 with expected ramp-up in execution of deal wins through capabilities acquired through SWC driving the improvement back to historical levels from fiscal 2026 onwards. The company continues to maintain a strong financial risk profile, and robust liquidity, which too are expected to continue over the medium term with continuing strong cash accruals, limited maintenance capex and dividend payments.

 

The ratings continue to factor in benefit from the strong managerial and operational support from its parent, Larsen & Toubro Ltd (L&T, rated CRISIL AAA/Stable/CRISIL A1+), and the overall strength of the L&T brand. These strengths are partially offset by its geographical concentration in its revenue profile and increasing competition in the business.

 

The ratings also reflect the strategic focus of the parent, L&T, towards service-based businesses such as information technology (IT), and financial services with the objective of reducing the dependence on capital intensive and low margin businesses. L&T has taken significant steps to consolidate and strengthen its services business including amalgamation of Mindtree Ltd (Mindtree) with Larsen and Toubro Infotech Limited to form LTIMindtree (‘CRISIL AAA/Stable/CRISIL A1+’). Over the years, the contribution of service based business towards group’s overall business, both in terms of revenue and profitability has also been improving.

Analytical Approach

For arriving at the ratings of LTTS, CRISIL Ratings has factored in support expected from its parent, L&T, considering the strategic importance of LTTS to L&T. The Parent, L&T with its strong reputation in the engineering and construction industry also finds congruence in LTTS’ products and service offerings. Moreover, the parent has also assisted LTTS in few business transfers in the past to LTTS viz. Product Engineering & Integrated Engineering Services divisions, and Smart World & Communication (SWC).

 

CRISIL Ratings has combined the business and financial risk profile of LTTS including the recently acquired SWC business of L&T, and its 11 subsidiaries.

 

With adoption of Ind AS 116 with effect from April 01, 2019, lease liabilities are treated as debt along-side adjustments are also made in depreciation and amortization and interest cost components.

 

Please refer Annexure - List of Entities Consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths:

• Large diversified clientele: The company has a large and diversified client base given its strong presence over the years across various verticals including telecom, automotive, aerospace, medical devices, industrial products, heavy machinery, construction, and consumer appliances. There has been growing interest in the past few years from clients across sectors in sourcing their engineering and Research and Development (R&D) requirements from India. Clients currently include 69 of the global fortune-500 companies and 57 of the top 100 R&D spenders. This has enabled the company to withstand the slowdown pressures as exposure is not restricted to a particular end-user industry.

 

On account of continuous focus on R&D and building new platforms solutions, the company has been able to expand the revenue share from existing clients and maintain steady acquisition of new clients. Similar growth and profitability is expected to be maintained over the medium term, thereby supporting the overall business risk profile.

 

• Strong financial risk profile: The company’s financial profile continues to be strongly supported by healthy cash accruals, debt free balance sheet and robust liquidity (cash surpluses of ~Rs. 2,269 crore as on September 30, 2023).  Finance lease liabilities as of September-2023 stood at Rs 551 crore (Rs 454 crore as of March 31, 2023). Capital spending is expected to remain moderate which along with incremental working capital needs are likely to be funded through cash accruals.

 

• Strong managerial, operational, and financial support from L&T; increased strategic importance of the IT business for the group: LTTS benefits from L&T's established position as an engineering specialist, given that the target market of the former is engineering design. Managerial and Operational support is available from L&T in the form of shared resources both managerial and infrastructure.

 

There is commonality in the board of directors and entire operational teams have moved as part of the strategic business unit (SBU) to LTTS. Even though the financial risk profile of LTTS is sound, support from the parent exists for any exigency. L&T had invested Rs 750 crore in the form of preference shares in the company in addition to Rs 300 crore of equity share capital for the buyout of these SBUs.

 

Further, being an L&T group company, LTTS also benefits from the strong brand and domain expertise available within the group, resulting in better penetration and acceptability in the market. Treasury operations are supported by L&T Treasury, and critical treasury decisions are taken by the Treasury Committee, which consists of members from L&T and LTTS.

 

The IT and technology services business has been becoming more critical to the L&T group in recent years. The group is presently focusing more on the services business, which includes financial, and IT and technology services, which are asset light, have healthy growth potential, and offer high return on capital employed. L&T has taken significant steps to consolidate and strengthen its services business including recently announced amalgamation of Mindtree Ltd (Mindtree) with Larsen and Toubro Infotech Limited to form LTIMindtree (‘CRISIL AAA/Stable/CRISIL A1+’). Over the years, the contribution of service-based business towards group’s overall business, both in terms of revenue and profitability has also been improving.

 

Weaknesses:

• Geographical concentration in revenue profile: Dependence on the US market is high, with over 62% of the revenue coming from the US in fiscal 2023, having increased from ~60% in fiscal 2018. Although geographical diversity mitigates business risk, the skew in revenue is unavoidable given that the US is the largest IT spender in the world, with the US contributing over 60% of the industry’s revenues. SWC acquisition has, however, led some improvement in revenue diversification given its India focused existing business which is expected to be ramped-up across geographies going-forward.

 

• Increasing competition in the engineering services business: LTTS is an engineering services provider focused on offering innovative design and development solutions across the product development value chain, for industries such as industrial products, transportation, aerospace, telecom and the process industry. Given the healthy growth prospects in this segment many IT firms have forayed into the engineering services business in the last few years resulting in increased competitive intensity.

 

Given the increasing competition and the resultant pricing pressures, the ability to introduce new innovative products/platforms will remain extremely critical to maintain competitive advantage. Further, players will have to maintain an efficient cost structure, ensuring effective resource retention and utilization while remaining responsive to the dynamic nature of the industry

Liquidity: Superior

The company is expected to generate cash accrual of Rs 1,300-1,400 crore over the medium term, which will be sufficient to annual capex and incremental working capital needs. The fund-based bank limits have witnessed negligible utilization during last twelve months ended November-2023. Moreover, cash and liquid surplus which moderated to Rs 2,269 crore as on September 30, 2023 from Rs 2,974 crore on March 31, 2023 owing to SWC acquisition (~Rs 800 crore) and dividend payments is expected to begin accretion with generation of accruals. There is no long-term financial debt, except for financial lease liabilities of Rs 551 crore on LTTS balance sheet as on September 30, 2023

Outlook: Stable

CRISIL Ratings believes LTTS’s business risk profile will be supported by healthy growth in engineering and research & development (R&D)-related information technology (IT) services, and its financial risk profile will remain comfortable in the absence of debt-funded capital expenditure (capex). CRISIL Ratings also believes LTTS will continue to receive managerial and technical support in case of any exigencies from L&T.

Rating Sensitivity factors

Downward Factors

• Significant decline in revenues by over 10% and deterioration of operating margin to below 12%, adversely impacting cash flows
• Sizeable debt-funded acquisition, leading to weakening of debt protection metrics or liquidity
• Change in the strategic focus of parent L&T towards service-based businesses and/or deterioration in credit risk profile of the parent.

 

ESG Profile

CRISIL Ratings believes that LTTS ’s Environment, Social, and Governance (ESG) profile supports its already strong credit risk profile.

 

The IT sector has a low impact on the environment because of the inherent nature of digital services, core operations as well as products. The sector has a social impact because of its large workforce. LTTS has continuously focused on mitigating its environmental and social impact. 

 

Key ESG highlights:

• LTTS  began releasing its sustainability report from fiscal 2021 setting out detailed parameters of the ESG and set specific targets for 2030 having committed to become carbon and water neutral
• Company has improved on its green-house gas related Scope 1 and 2 emissions having reduced scope 1 and 2 emission intensity to 0.24 MT co2 eq/million of INR revenue in fiscal 2023 from 0.274 in fiscal 2021
• Company has been improving renewable energy consumption with 5,260 GJ renewable energy consumed in fiscal 2023.
• Company has reported 22.5% women in the workforce and intends to reach 25% by 2025.
• It has adequate governance structure with 60% of its board comprising independent directors and extensive disclosures.

 

There is growing importance of ESG among investors and lenders. LTTS ’s commitment to ESG principles will play a key role in enhancing stakeholder confidence, given its high share of market borrowings in its overall debt and access to both domestic and foreign capital markets.

About the Company

LTTS is an engineering services provider incorporated in 2012, focused on offering innovative design and development solutions across the product development value chain, for industries such as industrial products, transportation, aerospace, telecommunications (telecom) and the process industry. As on September 30, 2023, L&T held 73.77% shares of LTTS.

 

The company was created by combining two strategic business units: Product Engineering Service (PES) from LTIMindtree (‘CRISIL AAA/Stable/CRISIL A1+’, erstwhile L&T Infotech Ltd) and Integrated engineering services (IES) from L&T, which were transferred to it on January 1, 2014, and April 1, 2014, respectively.

Any other information: Not applicable

Annexure - Details of Instrument(s)

ISIN	Name of the instrument	Date of Allotment	Coupon Rate (%)	Maturity Date	Issue size (Rs.Crore)	Complexity Level	Rating assigned with outlook
NA	Fund-based facilities*	NA	NA	NA	366	NA	CRISIL AAA/Stable
NA	Non-fund-based limit**	NA	NA	NA	455	NA	CRISIL A1+
NA	Proposed Fund-Based Bank Limits*	NA	NA	NA	434	NA	CRISIL AAA/Stable
NA	Proposed Non Fund based limits**	NA	NA	NA	745	NA	CRISIL A1+