Rating Rationale
January 21, 2020 | Mumbai
L&T Technology Services Limited
Long-term rating upgraded to 'CRISIL AAA/Stable'; short-term rating reaffirmed
 
Rating Action
Total Bank Loan Facilities Rated Rs.250 Crore
Long Term Rating CRISIL AAA/Stable (Upgraded from 'CRISIL AA+/Positive')
Short Term Rating CRISIL A1+ (Reaffirmed)
1 crore = 10 million
Refer to annexure for Details of Instruments & Bank Facilities
Detailed Rationale

CRISIL has upgraded its rating on the long-term bank facilities of L&T Technology Services Limited (LTTS) to 'CRISIL AAA/Stable' from 'CRISIL AA+/Positive' and reaffirmed its rating on short term bank facilities at 'CRISIL A1+'.
 
The upgrade reflects improvement in LTTS's business risk profile, supported by enhanced focus on new client acquisition, wider product offerings, and increasing share of business with existing clients.
 
Revenue for the first nine months of fiscal 2020 grew by 11.1% over the corresponding period of the previous fiscal driven by higher revenues from medical devices segment and transportation segment. Operating margin has also remained healthy at 20.6% in the first nine months of fiscal 2020.
 
The niche presence in value-added segments and focus on emerging areas such as medical devices, process engineering, and industrial automation will aid sustained healthy growth in revenue 10-15% and operating profitability of about 19% over the medium term. The company continues to maintain a healthy financial risk profile, and robust liquidity, which too are expected to continue over the medium term
 
The upgrade also reflects increased strategic focus of the parent, Larsen and Toubro Ltd (L&T; rated 'CRISIL AAA/FAAA/Stable/CRISIL A1+') under the L&T Nxt initiative 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 is eyeing more than USD 1 billion revenue from its newly launched new-age technology platform L&T Nxt in the next five to seven years and LTTS is set to play a major role in this. 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. Over the next 5 years, services business is expected to contribute ~35% of the group's revenue compared to ~19% currently.
 
The ratings continue to factor LTTS's strong presence in technology services with healthy growth prospects, and its strong financial risk profile. Furthermore, the company will continue to benefit from the strong managerial and operational support from its parent, and the overall strength of the L&T brand. These strengths are partially offset by its geographical concentration in its revenue profile.

Analytical Approach

* CRISIL has amortized the goodwill arising from LTTS's acquisition of the product engineering services (PES) vertical over 10 years.
* The ratings of L&T Technology Services Ltd factor in support expected from L&T. CRISIL believes that LTTS will in case of exigencies receive active support from its parent considering strategic importance of L&T Limited as LTTS relies heavily on engineering and the technical knowhow of the parent due to its reputation in the engineering and construction industry. Moreover, the parent has also assisted LTTS for acquisition of the two divisions (PES & IES) in the past.

Key Rating Drivers & Detailed Description
Strengths:
* Large diversified clientele
The company has a presence in engineering and research and development (R&D) services, which are relatively new segments. There has been growing interest in the past few years from clients across sectors (including telecom, automotive, aerospace, industrial products, heavy machinery, construction, and consumer appliances) in sourcing their engineering and R&D requirements from India. Clients currently include 69 of the global fortune-500 companies and 51 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 (21.1% revenue from the top five in the third quarter of fiscal 2020 against 27.4% in the corresponding period of the previous fiscal) 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, almost debt free balance sheet and robust liquidity (cash surpluses of ~Rs. 832 crore).  Capital spending is expected to remain moderate (Rs 123 crore was spent in the first nine months of 2020); this and 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. The 10% preference shares (redeemable at par) subscribed by L&T were converted to equity in May 2016, and the company was listed in September 2016.
 
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. Over the years, the contribution of the services business to the group, both in terms of revenue and profitability, has been improving. Additionally, L&T has been leveraging its services capabilities to grow its core infrastructure business. Its new strategic initiative, L&T Nxt, also bodes well for the services business. The company is eyeing more than USD 1 billion revenue from this newly launched new-age technology platform in the next 5-7 years and LTTS is set to play a major role in this. L&T's intent of acquiring Mindtree Ltd signifies L&T's intent to become larger and more credible player in the IT services and technology services business.
 
Weaknesses: 
* Geographical concentration in revenue profile
Dependence on the US market is high, with around 61.3% of the revenue coming from the US in fiscal 2019 and first nine months of fiscal 2020. 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.
 
* 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 about Rs 650-800 crore between fiscals 2020-2022, FY20-22 which will be sufficient to annual capex of Rs 80-100 crore and incremental working capital needs. The Rs. 120 crore fund based bank limits, have witnessed almost nil utilization during the nine-month period ended Dec 31, 2019. Moreover, cash and liquid surplus were about Rs 832 crore as on Dec 31, 2019 and is expected to be healthy over the medium term at similar or higher levels. LTTS has paid 20% of PAT as dividend for fiscal 2019 which is expected to continue over the medium term. Currently, there is no long-term debt on LTTS balance sheet as on Dec 31, 2019.

Outlook: Stable

CRISIL 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 also believes LTTS will continue to receive managerial, technical, and financial 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.
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 December 31, 2019, L&T holds 74.74% shares of LTTS.
 
The company was created by combining two strategic business units: Product Engineering Service (PES) from Larsen and Toubro Infotech Limited ('CRISIL AAA/Stable/CRISIL A1+'; 100% subsidiary of L&T) and integrated engineering services (IES) from L&T, which were transferred to it on January 1, 2014, and April 1, 2014, respectively.

Key Financial Indicators
As on/for the period ended March 31, Units 2019 2018
Revenue Rs. crore 4712 3507
Profit after tax^ Rs. crore 662 352
PAT margin^ % 13.9 9.8
Adjusted debt/adjusted net worth Times 0.02 NA
Interest coverage Times 909.27 1548.25
^CRISIL adjusted numbers
 
Key Financial Indicators - Year to date financials on standalone Basis:
  Units 9M-FY20 9M-FY19
Revenue Rs. crore 3857 3473
Profit after tax Rs. crore 599 515
PAT margin % 15.5 14.8
Adjusted debt/adjusted net worth Times NA NA
Interest coverage Times 36.66 941.75

Any other information: Not applicable

Note on complexity levels of the rated instrument:
CRISIL complexity levels are assigned to various types of financial instruments. The CRISIL complexity levels are available on www.crisil.com/complexity-levels. Users are advised to refer to the CRISIL complexity levels for instruments that they consider for investment. Users may also call the Customer Service Helpdesk with queries on specific instruments.
Annexure - Details of Instrument(s)
ISIN Name of instrument Date of allotment Coupon Rate (%) Maturity Date Issue size (Rs. Cr.) Rating assigned
with outlook
NA Fund-Based Facilities* NA NA NA 120 CRISIL AAA/Stable
NA Non-Fund Based Limit** NA NA NA 50 CRISIL A1+
NA Proposed Working Capital Facility NA NA NA 80 CRISIL AAA/Stable
*Fund Based - Cash Credit / Packing Credit (does not include term loan)
**Non-Fund Based - Letter of Credit / Bank Guarantee
Annexure - Rating History for last 3 Years
  Current 2020 (History) 2019  2018  2017  Start of 2017
Instrument Type Outstanding Amount Rating Date Rating Date Rating Date Rating Date Rating Rating
Fund-based Bank Facilities  LT/ST  200.00  CRISIL AAA/Stable      26-04-19  CRISIL AA+/Positive  29-01-18  CRISIL AA+/Stable  06-01-17  CRISIL AA+/Stable  CRISIL AA+/Stable 
Non Fund-based Bank Facilities  LT/ST  50.00  CRISIL A1+      26-04-19  CRISIL A1+  29-01-18  CRISIL A1+  06-01-17  CRISIL A1+  CRISIL A1+ 
All amounts are in Rs.Cr.
Annexure - Details of various bank facilities
Current facilities Previous facilities
Facility Amount (Rs.Crore) Rating Facility Amount (Rs.Crore) Rating
Fund-Based Facilities* 120 CRISIL AAA/Stable Fund-Based Facilities* 120 CRISIL AA+/Positive
Non-Fund Based Limit** 50 CRISIL A1+ Non-Fund Based Limit** 50 CRISIL A1+
Proposed Working Capital Facility 80 CRISIL AAA/Stable Proposed Working Capital Facility 80 CRISIL AA+/Positive
Total 250 -- Total 250 --
*Fund Based - Cash Credit / Packing Credit (does not include term loan)
**Non-Fund Based - Letter of Credit / Bank Guarantee
Links to related criteria
CRISILs Approach to Financial Ratios
CRISILs Bank Loan Ratings - process, scale and default recognition
Rating criteria for manufaturing and service sector companies
Rating Criteria for Software Industry
Criteria for Notching up Stand Alone Ratings of Companies based on Parent Support

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