Rating Rationale

Strengths:
* Dominant market position in the domestic E&C segment with diversified revenue: L&T's dominance in the domestic E&C segment is supported by the ability to cater to several sectors, an established track record of more than seven decades, and a strong brand image. The business mix spans a spectrum of projects, ranging from complex turnkey engineering, procurement, and construction (EPC) projects, to relatively simple construction activities. In-house design, engineering, and, importantly, fabrication capabilities for critical equipment and systems give a robust competitive advantage. These strong competencies across segments and sectors, along with a sound track record of completing projects as per specifications, have supported the robust brand image in India and abroad, as indicated by strong group level orders of Rs 2.9 lakh crore as on June 30, 2019. The company has diversified geographically, with international orders comprising 21% of the total. It is likely to maintain the dominant position in the E&C market in India by judiciously bidding for projects across segments such as infrastructure (power, roads), urban infrastructure, defence manufacturing, and nuclear. Also, revenue is expected to continue being diversified geographically.

* Strong financial flexibility and comfortable capital structure: The company has demonstrated its ability to raise funds at competitive rates, and had a significant cash balance (standalone cash and equivalents of around Rs 12,294 crore as on March 31, 2019). Healthy cash accrual of Rs 5,500-7,000 crore over past few fiscals, and periodic divestments have significantly improved the networth and augmented liquidity. However, additional investments in subsidiaries and higher working capital requirement have impacted the capital structure. Historically, the L&T group has displayed a conservative financial policy, as is evident in gearing of less than 0.5 time as on March 31, 2019.

Weaknesses
* High working capital intensity of operations; correction expected over the medium term: Gross current assets (GCAs) net of dues to customers and cash, though improved, remain high at 285 days as on March 31, 2019 (300 days a year earlier). However, overall liquidity has been efficiently managed through customer advances and creditors. Additionally, given the intent of the management to judiciously bid for projects with lower working capital intensity as well as efforts in reducing outstanding receivables and inventory, a gradual improvement in GCAs is expected and shall be a key rating monitorable over the medium term.

* Subdued returns from significant capital employed notwithstanding moderate debt service indicators: Return on capital employed (RoCE) improved in fiscal 2019, though the overall return remained constrained due to existing investments in developmental projects such as Nabha and LTMRHL as well as investments in projects that are yet to achieve commercial operations date (CoD), such as Uttaranchal Hydro Power. Highly geared build, operate, transfer projects are fraught with construction risks, which may lead to cost overrun in the pre-commercial operations phase, and temporary cash gap funding in the initial years post COD, which constrains significant improvement in RoCE. A stretched working capital cycle and subdued returns from investments in developmental projects and manufacturing companies such as shipbuilding and forgings are the key credit concerns. However, given the past track record and intent of management to judiciously bid for projects as well as focus on improving the operating profitability margin, as evident in fiscal 2019, further improvement in operating profitability is expected, resulting in a higher RoCE, over the medium term.

Leverage, as reflected in the debt/EBITDA (earnings before interest, tax, depreciation, and amortisation) ratio, has been steady, and stood at around 2.0 times as on March 31, 2019 on account of divestments and improved profitability. The company is expected to raise funds by divesting the stake in businesses such as electrical and automation (the transaction has been already approved by the Competition Commission of India in April 2019), and developmental projects over the medium term. Most of these proceeds are expected to be returned to shareholders in the form of dividends/buybacks and new investments in higher RoCE projects. Borrowing in absolute terms may increase in the interim to meet business requirement, but the debt/EBITDA ratio is expected to remain around 2.0 times in the medium term.

Liquidity: Superior
The group (as per CRISIL consolidation) has superior liquidity, driven by estimated cash accrual of around Rs 8,500 crore per annum in fiscals 2019 and 2020 as well as a significant cash balance. L&T also has access to a fund-based limit of Rs 10,000 crore (including o/s commercial paper of about Rs 7000 crore), which was moderately utilised. Cash accrual and cash and cash equivalents should be sufficient to meet repayment obligation and partly finance capital expenditure (capex) and investment requirement in various subsidiaries and JVs. With a gearing of less than 0.5 time as on March 31, 2019, there is sufficient headroom, to raise additional debt for capex. Unutilised bank lines are more than adequate to meet incremental working capital need over the next one year.