Larsen and Toubro Ltd (L&T) announced the sale of its Switchgear business to Schneider Electric two years ago. Given the delay in closing the deal, there was understandably nervousness among investors. Finally, the agreement is concluded and the company will receive ₹14,000 crore in cash, but there was no fireworks on the street. L&T shares remained stable.
While the deal is going to be positive, what is critical is what L&T plans to do with the product. The company has not set any specifications for the use of these products. But L&T is expected to use this money to reduce its debt and focus more on its core business. High exposure to non-core activities has been a concern for investors in this stock.
“We believe that if most of these proceeds are reinvested in the core business and in debt repayment, especially in the Hyderabad metro to make it a stand-alone project, confidence should gradually recover,” said analysts at Jefferies India Pvt. Ltd in a note dated August 31. According to Jefferies, the ₹The acquisition of 10,600 crore Mindtree in 2019 did not please investors. This cast doubt on the allocation of capital, as it went against management’s comment that its balance sheet was thin, the note added.
L & T’s total debt increased by ₹33,500 crore in the past two years ₹1.41 trillion at the end of fiscal 2020. It has increased by a further ₹14,300 crore in the June quarter of FY21 and stands at ₹1.55 trillion. Cyclical challenges in engineering and construction activities, the commissioning of the Hyderabad metro project and delays in reaching the Schneider deal have added to significant pressure on L & T’s balance sheet.
“The sharp increase in debt is mainly due to increased working capital requirements against a backdrop of slower execution in recent months. During the June quarter, L & T’s working capital as a percentage of revenues increased to 26.8%. L&T had previously guided to bring its In the absence of private capex, reaching this goal is difficult, but offloading some non-core assets would relieve some pressure on its working capital cycle, ”said Arafat Saiyed, vice president Deputy of Reliance Securities Ltd.
For the stock to regain its former glory, more divestments of non-core assets will be required, which will improve yield ratios.
Also, what could cap the short-term gains of the stock is the bleak outlook for the sector. As noted, tight fiscal space would maintain public spending on infrastructure and restrict the significant inflow of new orders. From its pre-covid highs earlier this year, the stock is still down around 30%.