Why L&T Stock is Falling?

L&T Stock Analysis & Future Prospects

Introduction

Larsen & Toubro (L&T) stock has fallen almost 15% from its recent high of Rs.1,009 to Rs.850 in last 1 month. What happened? Why L&T stock is falling? In this article, we have discussed the key reasons for the downtrend in L&T stock and also future prospects of the company.

Why Larsen & Toubro (L&T) Stock is Falling?

India’s major Construction, Engineering, Manufacturing and Technology conglomerate – Larsen & Toubro (L&T) Ltd declined almost 15% in last 1 month due to a number of Macroeconomic risks. Lets see why the stock is falling?

Larsen & Toubro (L&T) Share Price Trend

Let us see L&T Share price trend YTD (since January 1, 2020).

• From the above share price trend, we can see that L&T stock was at Rs.1,371 on January 30, 2020, when the markets were at all-time highs. Then the stock had reported a steep fall in March’20 and declined to its 52-week low at Rs.708 on March 24, 2020.
• In line with the market recovery, L&T share recovered and reached to the recent high of Rs.1,009 on August 19, 2020.
• However, in last 1 month, the stock has fallen almost 15% from its recent high of Rs.1,009 to Rs.850 as on September 24, 2020.
• What happened? Why L&T stock is falling? Let us take a look at the reasons for this decline in the share price.

Reasons behind the Recent Fall in L&T Stock

1. Overall Market Fall

• The recent fall in L&T stock is in line with the overall Market Corrections from its recent highs.
• India’s key benchmark Index – Nifty has corrected almost 7%-8% from the 11,600 level.
• Thus, on account of the current downturn in overall market, there is a higher selling pressure across Large caps and Blue-chip Stocks.

2. Passive Investors Selling

• Foreign Institutional Investors (FII) mostly invest  in Indian Markets via Passive Investing.
• Index Investing a major strategy used in Passive Investing. Since, through the Passive Investing, FIIs Invest in India’s Major Benchmarks/Indices like Sensex & Nifty.
• L&T is having significant weightage in Sensex : 3% and Nifty : 2.35%, on account of its high free-float market capitalization.
• So, in Passive Investors’ selling, there is high selling pressure built for major Index Stocks like L&T.

3. Overall Sluggishness in Private Investment

• We have understood the selling pressure through passive investing. But, why are Active Investors selling L&T stock then?
• The key reason is the drastic slowdown of Private Investment in Infrastructure sector.
• This dampened near-term outlook of private investments can have negative impact on L&T stock performance ahead.

4. High Fiscal Deficit may delay Government Spending

• In case of dampened Private Spending, Government Spendings ie. Government Capital Expenditure (Capex) come into the force to upbeat that stagnant mood.
• But, the Finances to meet Spending Requirements is a big challenge to the Government. Thus, the Government is having Spending Pressure. This likely government capital expenditure (Capex) cut appear challenging for the company.
• The current high Fiscal Deficit can build financing constraints over the Government Spending.
• Also, the Tax & Non-tax Revenue is falling short in Financing Government’s Spending programme.
  • In the shortage of revenue inflow, how can Government finance its Capex programme?
  • If Government increase borrowing from overseas, India’s Fiscal Deficit can swell even more. And the economy may get caught in this vicious cycle.
• Thus, for now, the planned Infrastructure Spending may get delayed.

5. Gap between Planning & Execution of Government Projects

• Government has increased its Infrastructure Spending Target for 2020-25 to Rs.111 Lakh Cr. So, Government’s big Capex budget for Infrastructure projects is very positive sign for the Infrastructure Sector.
• Thus, the Government is increasing the Portfolio of Infrastructure Projects like Railways, Roads, Highways to :
  1. Boost Economic Growth and
  2. Job Creation
• However, in spite of such a high Capex target of Rs.111 Lakh Cr, there is a considerably wide gap between the planning and the execution of these proposed infrastructure projects.
• It is because the financing for the Execution of Planned Projects is a key challenge for the Government currently.
• Thus, the big gap in Planning-Execution of Infra projects is a big challenge for infrastructure sector and unfavorable for L&T, since majority of the L&T Projects come from Government.

6. Delay in Payments from Government Side

• There is strong Project Pipeline with L&T for capable of  managing cashflows for next 4-5 years.
• The company is having no problem with the current in-hand Projects, however, the main problem is the Execution of these Projects.
• Being a strong group, L&T can spend funds for Execution, but difficulties in on-time Payments from Government-side can affect company.
• And because of the Delay in Payments from Government side, Private Investment from L&T-side is also going slow.

7. Labour Shortage & Rise in Labour Cost

• Labour Shortage
  • Amid recent Reverse Migration on the back of COVID-19 pandemic, not all 100% labour force re-joined (came-back % of labours is around 60-70%).
  • Thus, the shortage of labour will have negative impact on overall Labour Market. While, Infrastructure sector is a Labour-intensive sector. Being an Infrastructure conglomerate, L&T is facing the labour shortage problems.
• Rise in Labour Cost
  • On account of the shortage of Labour post the recent Reverse Migration, the Existing Labour Cost will be increased.
  • Moreover, the infusion of added Labour-force will further raise the Labour Cost. As a result. the overall operating cost will rise and will hamper Operating Profit Margins.
  • Consequently, the declined Operating Profit Margins will have a negative impact on Company’s Profitability.

8. L&T Finance Holding under Pressure

• The L&T Group is majorly engaged in core, high impact sectors of the economy.
• L&T is having well-performing IT Subsidiaries like Larsen & Toubro Infotech (LTI), L&T Technology Services, Mindtree etc.
• But, the Financial arm of the company – L&T Finance Holding is a Pain Point for L&T, with the current troubles in the NBFC Business.
• L&T leads in nearly every sphere of business it operates in, however, the company is not able to succeed in Finance Services Business.
• In Addition, L&T is trying to Sell its Asset Management Business ie. L&T Mutual Fund, which is not a positive sign for company.

Larsen & Toubro Ltd – Key Positives

• Larsen & Toubro (L&T) has completed the strategic divestment of its Electrical & Automation (L&T E&A) business to Schneider Electric. Schneider Electric a global player in energy management and automation.
• It is a all-cash deal valued at Rs.14,000 Cr and one of L&T’s biggest divestment so far in value terms.
• L&T’s exit from the E&A business is part of the strategic portfolio review process. Commenting on the closure of this divestment, L&T group chairman Mr. AM Naik mentioned :
  • The closure of divestment of the E&A business is a key milestone in our stated long-term strategy.
  • The challenge was to carve out a business of this scale, with minimum disruption to the sprawling customer base and do it all amid the constraints of a pandemic.
• From this divestment, the post-tax cash inflow to L&T would be around USD 1.4 Billion (around Rs.10,000 Cr).
• The company, so far has not shared any concrete plan for the cash proceeds, however there are some positive outcomings :
  1. To Strengthen the Balance sheet :
     • This all-cash deal will help L&T create a much stronger balance sheet and rise in company’s reserves.
     • These high reserves in current challenging outlook of COVID-led slowdown would create a great long-term value opportunities for L&T by focusing on key aspects of business.
  2. Or the Company can propose a Special Dividend of Rs.60-70 per share to its Existing Shareholders.

Future Prospects of L&T

• L&T sees prospects in the areas of Government buildings, Data centres, Healthcare Infra, Airports, Metro railways, Hydro projects, Expressways as well as onshore and offshore Hydrocarbon projects.
• However, this future prospects of Government’s projects is uncertain of the timelines when these projects will take off.
• Key Determining Factors likely to impact the order intake outlook :
  1. Dependence on large orders given their size
  2. Subdued Private Sector Capital Expenditure (capex)
  3. Short-term to Medium-term spending constraints on State and Central Governments
• It is expected that both state and central governments will soon start focusing on investment towards infrastructure building and job creation. This can likely ramp-up order intake from the overall public sector.
• However, L&T’s high base and its dependence on large infrastructure projects can limit near-term growth in order intake.
• The current COVID-19 pandemic and its fallout make it difficult to forecast the future with any degree of certainty.
• In FY2019-20 Annual Report of L&T, the group chairman Mr. AM Naik mentioned that : “The Company is hopeful that the second half, H2:FY2020-21 will indicate the better economic and business activity in terms of tendering, good liquidity and revival of labour and supply chains”.