Larsen & Toubro on Wednesday (July 26) said it will return money to shareholders if the cash surplus is much higher than the company's requirements.

In a recent interview with CNBC-TV18, R Shankar Raman, the whole-time director, and chief financial officer (CFO), said, "If the cash surplus of Larsen & Toubro surpasses the company's operational needs, they would proactively return the excess funds to their valued shareholders."

Below is the verbatim transcript of the interview.

Q: You did point out in the conference call that it was a non-margin accretive project that were being done. And they were also won when the commodities were procured at high prices. But you said it will be subdued for a couple of quarters. Can you tell us what you mean by subdued? Does it go below double digits? And when you say it'll improve in the fourth quarter, how much can it?

A: The context of all the conversation around the margin is the infrastructure segment. Because I think the hydrocarbon segment and the manufacturing segments have actually reported improvement in margin. So let's possibly dive into the infrastructure segment, which is where the margin pain is being experienced.

When I mentioned about absorption of costs that were committed in the post-COVID, post-war period, what I meant was the mix of jobs that we are currently executing has jobs, which have been won in the last 12 months, and jobs that have been won in the 18 months prior. So typically, we take about three years on average to complete a project. So the mix is generally behaving in this fashion. When we talk about non-margin accretive jobs, we're talking about the cost overrun we have had in the projects that we bagged in the late part of FY21 and in FY22, where the cost commitments could not have been delayed beyond a point because the end of the day, the project has to be completed to the customer. So waiting endlessly for costs to improve or inflation to come down would have been disastrous as outcome for the company. So we waited as long as we could and then went ahead and bitten the bullet, committed the costs and that has enabled us to actually report growth in sales volume now.

The momentum of sales growth that you see in the last quarter of the last year in the first quarter of the current year, is largely as a result of execution pace picking up so that we could complete projects on the time committed to our customers. So it became inevitable that the jobs that we were executing had inherently diluted margins than what we actually got the contracts with.

Now, this mix does not change overnight. Given the nature of the project business and having a 3-3.5 year lifecycle for its completion, the change in the mix would be gradual. So when I say it will be subdued in the next couple of quarters, what I meant was it is not as though the last of the high cost have gone out of the financial statements on June 30. There are still possibly 20 percent of our revenue coming from jobs, which have been affected by these inflationary pressures. And this 20 percent will come down to 10 percent to 5 percent to 0 percent over subsequent quarters. So it's very important that the mix of jobs that we have acquired in the recent past starts contributing to revenue generation. And once that happens, the change in the margin profile will become inevitable.

Q: I understood it perfectly even when you explain that at the conference call. What I'm only asking is that this 20 percent which you say are those because of the chronology non-accretive, will it take it below 10 percent of your margins?

A: See, currently, we are in margin construction, infrastructure business, and we reported a margin of 5.1 percent. 6.5 percent was the margin last year. I'm just talking about the infrastructure piece. On a normalized basis, this segment has the potential to make about an 8 percent margin. When you mix it up with the manufacturing activity that we have and the hydrocarbon business that we have, then the margin profile improves from eight percent for the infrastructure segment to a blended average of 9-9.25. That's where the margins will be. So our efforts would be through the subsequent quarters to discover our path back to that kind of line. Our guidance for the year, given out in May was 9 percent.

Q: So you're referring to core margins. I get that. Let me get to the buyback, though I have a lot more execution and project questions. Why the buyback, look at the share performance over the last year, it's a 50 percent rise, let's pull up the one-year chart and you will get an idea of what were you at – at Rs 1,700-1,800. Now, already at Rs 2,500-2,600. And this buyback will give you another 17-16 percent taking it to Rs 3,000. If you kept the money with you, it would anyway go to Rs 3,000. Look at the Jefferies and all of them, they're giving you a share price. Why are you giving money away to shareholders, why didn't you keep it?

A: Fortunately for us, even though there's a lot of stress in executing projects, it's not a very capital-intensive business. And if we are very discreet and thoughtful about capital allocation, the money would generate every year on a year-on-year (YoY) basis is available for servicing debt, which is very low in our books, the entire group debt is dominated by financial services debt. So if you exclude that, the debt levels are very low. So there is very little capital that is required to service the debt.

Now, we are actually trustees of shareholders. And it is a company that is owned by everybody and anybody. Now that is the case, I think our job is to make sure that we add value to shareholders. And one way to do that would be to have healthy profits and dividend. And whenever the surpluses are far higher than what the company requires looking at the next couple of years, its own investment program, and its own working capital requirements, the money is best given back to the shareholders. The whole idea of our philosophy is that we work for shareholders' value creation. We do believe this is a good return that we would provide to the shareholders. They waited for long and as I told you the first time ever in our history, we've ever been able to do this. Our belief is that we want to get onto a model, which will be cash generative, and hence, we will have a program of dividends on a healthy continuous basis, as well as periodically we will have to see how buybacks can be done. The share price per se does not determine this philosophy. The idea is we need to make sure we are high on RoE and we are able to have the shareholders have money in their hands.

Q: So you will soon be not just an EPS generating company, but also a yield generating company. I guess people will make those calculations. Since you're speaking about EPS and the RoE targets. Let me come to some of the financial parts MSCI has upgraded your ESG rating to BB from B. Now how does that work into the finances? Does that make it easier? I believe that you'll also have done an ESG audit of all your plants and you're working towards near zero living of the environment. So should we expect a lot of financial gains from this? And by when?

A: As I see it now, what drives us toward ESG is our own sense of responsibility towards a better planet. I think we are not looking at it merely from the point of view of how it would benefit financially. The cost of transition is a major topic world over. People are yet to figure out how this cost of transition will be financed. Ultimately, whether it will be channelised through the government to the public pocket is something that needs to be worked out. Since we are in the business of construction and projects etc. We inherently are carbon-emitting operations, we cut trees, we do things, and we actually destroy before we construct. So this process of deconstruction has to be compensated. So consequently, what we have got us working on is to see how to decrease the emissions. So we've set ourselves targets YoY as to how to reduce emissions progressively. For example, sourcing green power.

Q: I got that, forgive me, I'm sorry, I'm interrupting you, but it's just that I'm trying to pack in more questions. I just want to know whether at the moment it impacts your cost of capital. I mean, how quickly will you see it in terms of gains? Lower cost of capital?

A: No, I don't think you will see it soon in terms of lower cost of capital, but it does a lot to our emotional capital.

Q: you have won so many brilliant projects that I wanted to speak a little bit about the NEOM green hydrogen project as well. That's a huge one, isn't it? Even in terms of the amount of money worth over $2 billion. Do these projects from the Middle East come with higher margins?

A: Intrinsically, yes. It all depends on how smartly we execute the projects. Because I think the price points of markets outside India are definitely better. But the task of executing it in a foreign land, complying with foreign regulations, making sure that you meet the localisation requirements, etc, has its own cost impacts as well.

But having said that, I think it was very important for us to get the kind of pre-qualifications we've got. As we speak over $5 billion worth of solar green-related projects are executing in the Middle East, and Saudi Arabia actually is one of the largest markets.

So I think we do believe that we should be able to help the margin accretion overall, by executing these projects well. It has gone off to a good start. I must say that we had a very rough start because as we got into these projects, the module prices, the polysilicon prices, etc, shot through the roof. But then since it was such a global phenomenon, the clients were understanding. So we were able to redraw the timeline, wait for things to cool and then move forward. So to that extent, we've been able to de-risk. So there are risks, as is the case with any projects in solar green projects as well. But we hope that wiser by all our past experiences, we will do a better job.

Q: I know realty is a small piece for you. But it looks like a lot coming with very ambitious and very intelligent financing, if you please, this Capital Land India Trust Management, it's almost like self-financing your realty. And it also means a lot of office space, and then the residential space that you have tied up, with HDFC Capital Advisors. Together can this contribute to L&T’s kitty? Can you give any numbers and timelines?

A: At the moment, let me mention that over 12 million square feet of residential area is under development and over 15 million square feet of commercial area is under development. Our plan was to see how we can do about 50 million square feet. Obviously, I think it is capital-intensive business and you have to build, wait and then sell and realize the cash and that was going contra to our RoE plans. So we decided that we will actually use the best part of our skill sets, namely the design engineering, construction, marketing, etc. And get somebody who can finance the acquisition of the land and development of projects. And that's where the platforms that you spoke about come into play. So we will use the third party's funds platform, bring in our real estate development skills, and possibly get a return, which will be high on RoI because our investment will be low. But it is definitely in absolute terms lower than what we would do and we put that in our balance sheet directly and start to finish.

Q: Will you list it separately anytime soon?

A: No, I don't think there is a plan to do that. I think first we want to make sure that these revised transformative models actually work and we will possibly look at it in the next strategic plan perhaps.

For more details, watch the accompanying video

First Published:Jul 27, 2023 3:15 PM IST