Key Rating Drivers & Detailed Description

Strengths:

Robust order book and efficient order execution

L&T Hydrocarbon has a strong business risk profile driven by robust order book, geographic diversity and presence across the entire value chain of the oil & gas business. Due to strong and quality counterparties, the company is able to maintain low level of operating assets that results in negative working capital cycle thus helps it quickly churn the orders and optimize the returns.

Unexecuted orders of around Rs 46,000 crore along with expected order inflows of around Rs 20,000-22,000 crore over the medium term provide strong revenue visibility for the next three fiscals. Order booking, despite being weak in the first half of fiscal 2021, improved over the second half of the fiscal with sharp rebound in crude oil prices, signifying better prospects for the oil and gas industry and finally for the engineering, procurement and construction (EPC) industry. Profitability also improved backed by increased execution, rich mix and stage of execution. Going forward, it is expected at 8-10% with continued favorable mix and improved utilization. However, due to fixed price nature of the contracts, the company’s profitability remains exposed to the risk of adverse movement in the commodity prices.

Strategic importance to the parent, L&T

L&T Hydrocarbon is L&T's wholly owned subsidiary operating in the hydrocarbon EPC segment and is critical to L&T's overall growth. Unexecuted orders in the hydrocarbon segment accounted for around 14% of the overall EPC order book while RoCE was robust at ~35% on-average for last 4 years. The company will remain strategically important to the parent over the medium term.

Strong managerial and financial support expected from L&T

The company receives strong managerial and financial support from the parent. The company's board of directors includes the L&T group’s CFO, Mr R Shankar Raman, and the CEO and MD of L&T Hydrocarbon, Mr Subramanian Sarma, is an executive director on the board of L&T. The parent has infused need-based funds by way of long-term convertible preference shares of Rs 760 crore. Led by continued accretion of higher profit in the past three fiscals, the company redeemed Rs 260 crore of preference shares during the current fiscal.

Weakness:

Exposure to intense competition, concentration risk and cyclicality in the oil and gas sector

The company faces competition in the hydrocarbon EPC segment, especially in the overseas markets. It is also exposed to the risk of concentration and cyclicality in the oil and gas sector, which together impact revenue, profitability and cash flow. Operating performance and gross current assets significantly weakened during fiscals 2014 and 2015 owing to fewer orders, cost overruns in some of the overseas orders and maturing stage of projects. However, since fiscal 2016, there has been steady improvement in performance driven by judicious bidding of projects, with focus on quality projects, and strong counterparties.

Cyclicality is likely to have a lower impact over the medium term on account of the judicious bidding strategy and expanding project basket. Nevertheless, it remains exposed to capital expenditure (capex) growth in the oil and gas sector as a result of high volatility in prices globally.

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