Rating Rationale

Strengths
* Dominant market position in domestic E&C segment with diversified revenue profile: L&T's dominance in the domestic E&C segment is supported by its ability to cater to several sectors, an established track record of more than seven decades, and a strong brand image. The business mix spans a spectrum of projects, ranging from complex turnkey engineering, procurement, and construction (EPC) projects, to relatively simple construction activities. In-house design, engineering, and, importantly, fabrication capabilities for critical equipment and systems give a strong competitive advantage. These strong competencies across segments and sectors, along with a sound track record of completing projects as per specifications, have supported L&T's robust brand image in India and abroad, as indicated by a strong group level order book of Rs 3.06 lakh crore as on December 31, 2019. The company has diversified geographically, with international orders comprising 23% of the total order book as on December 31, 2019. CRISIL believes the company will maintain its dominant position in the E&C market in India by judiciously bidding for projects across segments such as infrastructure (power, roads), urban infrastructure, defence manufacturing, and nuclear. Also, revenue is expected to continue being diversified geographically.

* Strong financial flexibility and comfortable capital structure: Strong financial flexibility is driven by the company's demonstrated ability to raise funds at competitive rates, and significant cash balance (standalone cash and equivalents of around Rs 12,294 crore as on March 31, 2019). Healthy cash accrual of around Rs 5,500-7,000 crore over past few years, and periodic divestments have significantly improved the networth and augmented liquidity. While L&T's net worth has improved significantly over the years, on account of the strong cash accruals, its impact on the capital structure has been partly offset by the additional investments in subsidiaries and the higher working capital requirements. Historically, the L&T group has displayed a conservative financial policy, as is evident in gearing of less than 0.5 times as on March 31, 2019.

Weaknesses
* High working capital intensity of operations with correction expected over the near to medium term: Gross current assets (GCA) net of dues to customers and cash, though improved, remains high at 285 days as on March 31, 2019 (vs 300 days in the previous fiscal). However the Company has demonstrated ability to manage overall liquidity through customer advances and creditors. Additionally, given the intent of the management to judiciously bid for the projects with lower working capital intensity as well as efforts in reducing outstanding receivables and inventory, CRISIL expects gradual improvements in GCA from the current levels and shall be a key rating monitorable over the medium term.

* Subdued returns from significant capital employed notwithstanding moderate levels of debt service indicators: Return on capital employed (RoCE) improved in fiscal 2019, though the overall returns remain constrained due to existing investments in developmental projects such as Nabha and Hyderabad Metro. Highly geared build, operate, transfer projects are fraught with construction risks which may lead to cost overrun in the pre-commercial operations phase, and temporary cash gap funding in the initial years post COD, which constrains significant improvements in RoCE. A stretched working capital cycle and subdued returns from investments in developmental projects and manufacturing companies such as shipbuilding and forgings are the key credit concerns. However, given the past track record and intent of management to judiciously bid for projects as well as focus on improving the operating profitability margin, as evident in fiscal 2019, CRISIL expects further improvement in operating profitability, resulting in a higher RoCE, over the medium term.

Leverage levels as reflected in Debt/EBITDA has is steady at around 2.0 times as on March 31, 2019 on account of divestments and improved profitability. Going forward, L&T is expected to raise funds by divesting the stake in businesses such as electrical and automation business (transaction is already approved by Competition Commission of India in April 2019), and developmental projects over the medium term. Most of these proceeds is expected to be returned to shareholders in the form of dividends/buybacks and new investments in higher ROCE projects. Borrowing levels in absolute terms may increase in the interim to meet business requirements, but debt/EBITDA ratio is expected to remain around 2.0 times in the medium term.