What is the logic behind the L&T buyback

L&T board announces mega buyback plans

Larsen & Toubro, along with its results announcement for Q1FY24 quarter, also put in motion its buyback plans. The total size of the buyback of shares would be to the tune of Rs10,000 crore. Exactly 4 years back, L&T had announced a buyback of shares to the tune of Rs9,000 crore. However, at that point of time, the regulator had asked L&T to shelve the buyback plans as its total debt (including group debt had crossed the minimum limit. 

This time around in 2023, L&T will buy back a total of 3.33 crore equity shares with face value of Rs2 each, at a maximum price of Rs3,000 per equity share. This will translate into an equity buyback value of Rs10,000 crore and would represent nearly 2.4% of the paid up capital of the company. To the extent of the shares bought back, the outstanding shares of L&T would come down and that would boost the EPS of the company and also, technically, its valuations in the market. 

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What is the intent behind the buyback of shares?

To understand the core intent of the buyback, one must just rewind back to the Lakshya Initiative announced by the company. Under the Lakshya initiative, L&T proposes to nearly double its return on equity (ROE) from the current level of 9% to 18% by FY26. This boost to ROE would be achieved largely through hiving off some of the non-core businesses of L&T group. This buyback of shares is also aimed at reduction of the outstanding equity and boosting the ROE by making use of its surplus cash at this point of time. 

The shareholders are getting  premium to the current market price and that is all the more attractive considering that the stock is already up 44% in year 2023. According to the group CFO, Mr. R Shankar Raman, while the ROE boost is one of the aims, it also wants to use the cash resources of the company to return the wealth to shareholders together with dividend which now accounts for 40% of profits. In recent months, the stock has also gained from a singular boost to a revival in the capital investment cycle in India. This has resulted in overflowing order book positions for L&T, which are already at record levels.

Low debt means, L&T can focus on working capital management

For a company with the size and dominance, its profits are still quite low. For the latest quarter to June 2023, L&T reported 34% growth in revenues to Rs47,882 crore while the net profits grew by 46% to Rs2,493 crore. That translates into net margins of just about 5.2% and that is what L&T is working on. In recent times, much of the profits of the L&T group at a consolidated level have come from IT and financial services. Its business model is shifting towards a more asset-light model so most of the capital guzzling businesses are either making an exit or they are being tweaked to become more asset-light businesses.

Due to these efforts, the working has already been pared from 26% of revenues to just about 16% of revenues. The core L&T aims to be net zero debt by the end of 2023 and that would give a lot of relief for the company financials and analysts are also likely to look more favourably at L&T as an investment destination. Debt levels are already manageable if the debt of the financial services business is excluded, which was one of the reasons for the 2019 buyback being rejected. The idea is to reduce capital locked in working capital assets.

Why 2019 buyback was rejected and what is different now?

It may be recollected that earlier in the year 2019, L&T had attempted a buyback of shares. At that point, the plan was to buyback 61 million shares at the price of Rs1,475 totalling to Rs9,000 crore. However, the proposal was then rejected by SEBI on the grounds that one of the necessary preconditions for a buyback was not met. The group leverage for L&T was too high and it would have been more than twice the paid up capital and free reserves, if there was full acceptance of the offer. However, the issue even at that point of time was with the finance subsidiary of L&T group. That had apparently overstated the leverage of the group, although the leverage of the financial services business cannot be considered technically as leverage since they are just the inputs to give out loans. So, what has changed now?

L&T has reduced the size of the buyback and since the price has doubled, the value is nearly the same. However, L&T has done a lot of spade work and worked closely with SEBI on this issue. The guidelines have now been made more granular. Under the modified guidelines in the case of buyback of shares, as long as the leverage of the financial services business is less that 6:1 (6 times of equity to debt), the debt of the finance companies in the group would be excluded. That has given a lot more clarity and by the modified definition, L&T is eligible to go ahead with this buyback. Hence, the buyback in 2023 should not really pose a problem. In terms of institutional ownership structure of L&T; foreign portfolio investors (FPIs) hold 25% of L&T’s equity capital, financial institutions hold 13.62% and domestic mutual funds hold 17.2%. L&T will be using the tender route through the stock exchange mechanism to carry out the buyback of shares this time around. This time around, the buyback promises to be value accretive to the company and to shareholders.