Detailed Rationale

CRISIL Ratings has assigned its ‘CRISIL AAA/Stable’ rating to Rs 2,000 crore proposed non-convertible debentures (NCDs) of Larsen and Toubro Limited (L&T; part of the L&T group) and has reaffirmed its ‘CRISIL AAA/Stable/CRISIL A1+’ ratings on the bank facilities and existing debt instruments of the company.

 

The ratings reflect the dominant position of the L&T group in the engineering, procurement and construction (EPC) market in India, its diversified presence, strong financial risk profile and robust financial flexibility. These strengths are partially offset by large working capital requirement in the EPC segment.

 

Consolidated revenue, excluding financial services, rose 36% on year to around Rs 44,862 crore in the first quarter of fiscal 2024, driven by strong execution growth in EPC business and resilient growth in the information technology and technology services (IT&TS) segments. Earnings before interest, tax, depreciation and amortization (EBITDA) margin, excluding financial services, remained healthy at 10.9%, driven by healthy growth in the EPC business, resulting in healthy operating leverage as well as sustained margins of the IT&TS segment.  As on June 30, 2023 the unexecuted order book stood at Rs 4.1 lakh crore coupled with healthy sector outlook which provides good prospects for the growth of L&T’s topline while sustaining its profitability.

 

For fiscal 2023, adjusted net debt to Ebitda ratio stood at 0.5 time, including capital allocation for the financial services business. Leverage measured in terms of net debt to EBITDA is expected to temporarily rise in fiscal 2024 owing to Rs 10,000 crore share buyback during September 2023. However, it is expected to return back to normal levels over the medium term driven by healthy cash accruals and divestments.

Analytical Approach

CRISIL Ratings has used a combination of full, proportionate and moderate consolidation of the L&T group companies. It has used the capital allocation method for the subsidiaries in the financial services business, by factoring in the capital required for maintaining their credit profile.

 

CRISIL Ratings has fully consolidated subsidiaries, including infrastructure holding companies - L&T Power Development Ltd (L&T PDL) and L&T Realty Developers Ltd (L&T Realty), because these entities form a core part of the business risk profile of L&T.

 

CRISIL Ratings has fully consolidated the special-purpose vehicle (SPV), L&T Metro Rail (Hyderabad) Ltd (LTMRHL; rated ‘CRISIL AAA(CE)/Stable/CRISIL A1+’), as L&T is providing guarantee for its debt instruments. Debt in the remaining infrastructure SPVs has not been consolidated as the debt is non-recourse to L&T. However, in line with the moderate consolidation approach, CRISIL Ratings has factored in support from L&T to fund any equity requirement, cost overruns and debt obligation in these SPVs.

 

CRISIL Ratings has proportionately consolidated two joint ventures (JVs) to the extent of the shareholding of L&T to reflect support required to the extent of its interests in these businesses.

 

CRISL Ratings continues to not consolidate Nabha Power Limited (NPL; rated ‘CRISIL AA/Stable/CRISIL A1+’) as the corporate guarantee extended by L&T cease to exist upon full drawdown from refinancing tied-up with PFC Ltd. Further, the company has been considered as a part of non-core assets by L&T and the parent has publicly articulated its intent to divest the asset.

 

To arrive at the adjusted net debt, surplus cash (cash exceeding Rs 5,500 crore which is assumed as minimum operational cash) has been reduced.

 

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

• Dominant position in the domestic EPC segment and diversified revenue profile: The L&T group’s dominance in the domestic EPC segment is supported by its track record of more than seven decades, ability to cater to several sectors and strong brand. The business spans a spectrum of projects, ranging from complex turnkey EPC projects to simple construction activities. In-house design, engineering and fabrication capabilities for critical equipment and systems give a strong competitive advantage. Strong competencies across segments and sectors along with a track record of completing projects as per specifications have led to a robust brand image in India and overseas.

 

As of June 2023, the group had orders of Rs 4.1 lakh crore, led by the infrastructure segment (73%), energy segment (18%), the hi-tech manufacturing (6%) and the rest from other segments. International orders accounted for 29% of the order book with bulk of the orders from the Middle East. These should provide strong revenue visibility of over three years.

 

The group enjoys strong diversity supported by increasing revenue contribution of the service-oriented businesses - IT&TS and financial services, which accounted for around 29% of consolidated revenue in fiscal 2023.

 

CRISIL Ratings believes the L&T group will maintain its dominant position in the EPC market in India by judiciously bidding for projects across infrastructure, defense, solar, energy storage and water treatment sectors.

 

• Healthy capital structure and robust financial flexibility: The group has a conservative financial policy, as reflecting in adjusted net debt to Ebitda ratio of 0.5 time as on March 31, 2023 including capital allocation for the finance subsidiary driven by strong cash accrual built up through core business. Leverage measured in terms of net debt to EBITDA is expected to temporarily rise in fiscal 2024 owing to Rs 10,000 crore share buyback during September 2023. However, it is expected to return back to normal levels over the medium term driven by healthy cash accruals and divestments.

 

The financial flexibility is supported by the group’s ability to raise funds at competitive rates as well as robust cash and equivalent of more than Rs 23,700 crore (CRISIL adjusted) as of March 2023. It is also bolstered by significant market value of the listed investments in the IT&TS and financial services companies. CRISIL Ratings expects the capital structure, debt protection metrics and financial flexibility to remain strong.

 

• Healthy share of the high-margin IT&TS segment: Share of the IT&TS segment in the revenue and operating profitability stands around 22% and 38%, respectively on consolidated basis during fiscal 2023. The IT&TS segment is a high-margin business and lesser working capital intensive than the EPC segment, resulting in higher return on capital employed (adjusted RoCE). Consolidated adjusted RoCE has been above 15% over the past five years ending fiscal 2023. CRISIL Ratings expects the RoCE to remain strong with better profitability.

 

Weaknesses

• Large working capital requirement: Gross current assets (GCAs) net of cash were large at around 265 days as on March 31, 2023. The group manages working capital efficiently through customer advances and payables. Order book is well diversified across sector and geographies which mitigates the credit risk. The rising revenue share of IT&TS has also helped contain the working capital requirement with standalone GCAs being higher.

 

Given the intent of the management to judiciously bid for projects with lower working capital requirement and its efforts to reduce receivables and inventory, GCAs are expected to decline and will be a key monitorable over the medium term.

 

• Significant capital employed in low-return developmental projects: Substantial capital is employed in the developmental projects under LTMRHL. The operations of LTMRHL, which commissioned around six years ago with significant time and cost overruns, was adversely impacted by the lockdowns due to the Covid-19 pandemic. As a result, daily traffic had declined sharply to less than 2 lakh commuters. Gradual recovery in traffic to over 5 lakh commuters per day was reached in July 2023.

Liquidity: Superior

L&T has robust liquidity, driven by cash and equivalent of around Rs 23,700 crore (CRISIL adjusted) as of March 2023. Expected net cash accrual of more than Rs 10,000 crore in fiscals 2024 and 2025, should suffice to cover the incremental working capital, capital expenditure, scheduled debt obligation as well as support towards its subsidiaries, including LTMRHL.

 

ESG profile

The EPC sector has a significant environment and social impact given its nature of operations with higher emissions, waste generation and water consumption affecting local community and increasing possibility of health hazards.

 

However, CRISIL Ratings believes that L&T’s environment, social, and governance (ESG) profile supports its already strong credit risk profile. The company is taking a slew of initiatives towards environmental and social causes, some of which are highlighted below.

 

Key ESG Highlights of L&T:

• L&T has committed to Water and Carbon Neutrality by 2035 and 2040, respectively.
• Portfolio of green businesses, which includes solar, water, green hydrogen and some other
  renewable projects, is growing steadily and presently constitutes about 37% of the total revenue.
• In fiscal 2023, the company spent Rs 29 crore on activities on environmental measures.
• During fiscal 2023, the company’s Lost Time Injury Frequency rate (LTIFR) stood at 0.06.
• The governance structure of L&T is characterized by 44% of its board comprising independent directors, split between the chairman and CEO positions, a dedicated investor grievance redressal system and extensive disclosures.

 

There is growing importance of ESG among investors and lenders. L&T’s commitment to ESG will play a key role in enhancing stakeholder confidence, given the high shareholding by foreign portfolio investors and access to both domestic and foreign capital markets.

Outlook: Stable

CRISIL Ratings believes L&T will maintain its leadership position in the EPC segment in India and is positioned to benefit from the infrastructure spending in India over the medium term. Its profitability is expected to be stable, supported by the increasing contribution of the IT business.

Rating Sensitivity Factors

Downward Factors

• Significant stretch in the working capital cycle on a sustained basis
• Significant decline in ROCE below 14% on a sustained basis

About the Company

Set up in 1938 by Mr HH Larsen and Mr SK Toubro, L&T was incorporated in 1946 and reconstituted as a public limited company in 1950. It is one of Asia’s largest vertically integrated EPC conglomerates, with a strong market position across segments such as infrastructure, power, hydrocarbons, heavy engineering, defense engineering, electrical and automation, IT, IT&TS, metallurgical and material handling, and machinery and industrial products. L&T undertakes infrastructure development projects (roads, metro rail, power and transmission lines) through its SPVs:  L&T PDL and LTMRHL.

Any other information: Not applicable

Annexure - Details of Instrument(s)

ISIN	Type of instrument	Date of allotment	Coupon  rate (%)	Maturity date	Issue size (Rs.Crore)	Complexity level	Rating assigned with outlook
INE018A08BF6	NCDs	23-Apr-20	8%	23-Apr-30	1,800	Simple	CRISIL AAA/Stable
INE018A08BB5	NCDs	6-May-20	7.25%	06-May-24	1,450	Simple	CRISIL AAA/Stable
INE018A08BA7	NCDs	28-Apr-20	7.7%	28-April-25	2,500	Simple	CRISIL AAA/Stable
INE018A08BE9	NCDs	28-Mar-23	7.725%	28-Apr-28	2,000	Simple	CRISIL AAA/Stable
INE018A08BG4	NCDs	08-Jun-23	7.34%	09-Sep-24	1000	Simple	CRISIL AAA/Stable
INE018A08BH2	NCDs	08-Jun-23	7.33%	09-Dec-24	1500	Simple	CRISIL AAA/Stable
INE018A08BI0	NCDs	08-Jun-23	7.38%	10-Jun-24	1000	Simple	CRISIL AAA/Stable
NA	NCDs*	NA	NA	NA	3,500	Simple	CRISIL AAA/Stable
NA	Commercial paper	NA	NA	7-365 days	13,500	Simple	CRISIL A1+
NA	Fund-based facilities	NA	NA	NA	3,684	NA	CRISIL AAA/Stable
NA	Proposed Fund-based bank limits	NA	NA	NA	6,316	NA	CRISIL AAA/Stable
NA	Fixed deposits	NA	NA	NA	0	Simple	CRISIL AAA/Stable
NA	Non-fund based limit	NA	NA	NA	105,256	NA	CRISIL AAA/Stable
NA	Proposed Non Fund Based Facility	NA	NA	NA	6,244	NA	CRISIL AAA/Stable

*Yet to be placed