What Next For L&T After SEBI Rejects Buyback Proposal?

India’s market regulator rejected Larsen & Toubro’s Rs 9,000-crore share buyback, citing a sharp rise in the debt-to-equity ratio if the buyback went through.

The construction and capital goods firm had proposed to buy back 6.1 crore shares at Rs 1,475 apiece comprising 18.72 percent of the company’s net worth and filed an application with SEBI on Oct. 10, last year.

L&T’s consolidated debt-to-equity ratio is at 1.77 times, as of September 2018. It would cross more than two times, if it went ahead with the share buyback, as per BloombergQuint’s calculations.

Here’s what brokerages made of SEBI’s rejection and the road ahead for L&T

CLSA

• Believes the regulator is mistaken in looking at consolidated financials, particularly when L&T has not guaranteed the debt of L&T Finance—47 percent of consolidated debt.
• Given its focus on return-on-equity enhancement, it thinks L&T’s board could approve a one-time large dividend (about Rs 53 a share) this week. This would help L&T’s ROE to expand (120 basis points in FY20 versus current estimates) on the reallocation of capital.
• Recommends buying L&T as it’s a good proxy for domestic capex and the company has a credible strategy to improve both growth and ROE.

Goldman Sachs

• Sees this as a potentially negative news flow for L&T as this was one of the steps to be taken by the company to reach its target ROE of 18 percent by FY21.
• Any potential buyback could have further helped L&T reach its ROE target.
• It expects the company to proceed with its plans to meet its ROE target, including the sale of its electrical and automation division.

JPMorgan

• SEBI’s denial is a negative surprise.
• The buyback would have depressed earnings per share slightly but improved consolidated ROE by about 130 basis points, keeping L&T on track to achieve its medium-term ROE target of 18 percent.
• It also denies an investor the opportunity to tender 4.3 percent of shareholding at about 12 percent premium to current price (record date for buyback was Oct 15).

Macquarie

• L&T can explore alternative methods to redistribute excess capital.
• Believes the regulator’s view to consolidate debt of L&T Financial Services is too conservative.
• Knee-jerk reaction possible, but it would create an opportunity to buy the stock.
• Company could reaffirm its stance of distributing excess capital to shareholders.

Nomura

• Even a reduced-sized buyback is not feasible under SEBI’s interpretation of guidelines. On a net debt basis, the ratio is at 1.89x, which would allow a reduced buyback size of just Rs 1,700 crore.
• Special dividend is an alternative since buyback option is effectively ruled out post SEBI’s ruling.
• Cancellation of buyback poses risks to our ROE estimates by about 150 basis points.

UBS

• Buyback was the preferred way to return cash compared to special dividend, which is tax inefficient as L&T has decided to not allocate capital to asset-heavy businesses.
• Proposed buyback rejection to dampen investor sentiments.
• Near-term prospects weak, medium term doesn’t look bright either.