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L&T to reinvent itself with cement demerger, export focus

NetScribes/Kasturirangan P

The proposed demerger of engineering, procurement and commissioning major Larsen & Toubro's cement business is a well thought-out strategy to separate the loss-making division from the profitable core EPC business.

The damage the cement division has done is clear from the fact that L&T's bottomline has been severely eroded over the past few years despite the topline growing by as much as 38 per cent over the past three years.

Though turnover rose 38 per cent between financial years 1998 and 2001 - Rs 57 billion to Rs 78 billon - net profits fell 69 per cent, from Rs 5 billion to Rs 3 billion. The ratio of net profit to sales - net profit margin -- also fell from 9.36 per cent to 4.02.

Why cement capacity was expanded

A few years back L&T had expected cement to become a money-spinner. In early 1997, the then managing director S D Kulkarni had said: "We plan to have a 12-million tonne capacity by 1998 to meet India's infrastructure needs."

The EPC major now has a 15-million tonne capacity, plus the 1 million tonne grinding unit being set up in Durgapur. "Part of the reason for the expansion was to avail of tax holidays," says an analyst from equity research firm Batlivala & Karani.

But there was another reason for the expansion. L&T's surplus earnings from the lucrative engineering division had to be routed to a profitable venture and cement was an obvious choice as the sector was booming at that point in time.

L&T's objective to achieve a rate of return of over 16 per cent seemed entirely possible because the prevailing cement prices were over Rs 160 per 50-kg bag. Hence, the investment on expansion was justified then.

The engineering giant set up about 7 million tonne cement capacity over five years, sinking about Rs 31.5 billion (at Rs 4,500 per tonne) into these plants. Most of the financing was done through internal accruals and borrowings.

How the cement cookie crumbled

But things began to go wrong in 1998. Cement prices began to move southwards. The abysmally low level demand for the commodity fell, and cement makers were saddled with excess capacity.

Also, input costs spiralled. Cement Manufacturers Association figures show that input costs rose, on an average, by Rs 8 per 50-kg bag every year since 1997. Falling fortunes of cement thus eroded the engineering division's profits.

L&T's net losses from cement were Rs 2.2 billion in fiscal 2001. By contrast, the EPC, electrical division and other businesses of L&T raked in net profits of Rs 5 billion, states a Batlivala & Karani report.

"Rising input costs have meant that most cement companies don't earn even the minimum 16 per cent rate of return," reveals director (operations) of L&T Mohan Karnani.

Hence, the need to hive off the cement business to save the EPC division. A joint venture partner is being sought for the cement company, which will be formed in six months, as per the Boston Consulting Group's recommendations.

Lafarge and Holderbank are the main contenders for the JV in which L&T and the partner will hold 37.5 per cent each, with the balance for the public. L&T's 16 million tonne capacity is pegged at Rs 69 billion (Rs 4,300 per tonne) by industry sources.

It must be mentioned here that though the cement sector may have turned to dust in the past few years, the rising infrastructure needs of the country are expected to lead to a boom in the industry.

The consolidation of cement units within the country and the acquisition of many sick cement companies by global giants like Lafarge are a pointer to this fact.

Refocusing on core competence

With the cement bug practically out of his hair, L&T's chief executive officer and managing director A M Naik is looking at the export market for growth in view of the slowdown in the domestic capital goods sector.

Leveraging its technical capabilities and leadership position, L&T plans to aggressively target the export market to expand its Rs 57 billion EPC business, which constitutes 58 per cent of L&T's turnover.

"With our world-class engineering capabilities, we are targeting the Far East, Middle East, Europe and US markets," says Naik. "We will enter every single market that we can," says A Ramakrishna, president and board member, in charge of projects.

But Naik is unfazed even by the capital goods sector slowdown. "Despite weak domestic demand, L&T's order book position grew by 38 per cent in fiscal 2001."

The capital goods sector's growth fell from 11.8 to 1.4 per cent in the last two years. There is over-capacity in user industries like steel and paper; infrastructure growth is slow and MNCs' aggressive entry pricing has eroded EPC companies' margins.

However, if all goes according to management consultant BCG's plans, L&T sans its cement business will become a leaner and meaner body in six months with its balance sheet then reflecting its true worth.

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