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One of the key beneficiaries of the Insolvency and Bankruptcy Code (IBC) has been the steel sector, with four large accounts having been resolved through this route so far. While financial creditors have so far realised ₹ 444 billion, an additional ₹ 600 billion could be realised once the resolution process for another two large entities, which have been mired in unending litigations, is finalised. As per ICRA’s estimates, the combined plant utilisation of these assets was about 72% in FY2018, which could be considerably ramped-up once the new promoters acquired the same. With incremental steel consumption expected to increase by around 28 million MT by FY2022, increased utilisation from these plants would also be critical in reducing the projected supply deficit and curtailing dependence on imports.

ICRA’s analysis of the Q3 results of a sample of companies shows that while revenue growth has been robust, driven by both commodity and the consumer-oriented sectors, aggregate EBIDTA margins declined both on a YoY and a QoQ basis because of a rise in energy and raw material costs as well as the adverse impact of the rupee depreciation. While sectors such as airlines, cement and building material reported a decline in margins because of the increase in fuel prices, others like automobile OEMs, consumer durables and paints were affected because of the rising input costs. One of the positive takeaways is that demand growth across key sectors like cement and steel remained robust, supported by a buoyant construction activity.

We also look at the Indian auto component industry that has grown at a healthy CAGR of around 8.3% (from FY2014 to FY2018), on the back of steady demand from the OEM, replacement markets and exports. Going forward, over the next three to five years, ICRA expects the industry to grow at around 9-11%, supported by increasing localisation and higher component content per vehicle. Also, the industry is expected to see significant investments for supporting new products and capacities as well as modernisation to meet BS VI standards. As a result, capex as a percentage of sales, is likely to be much higher than what it has been in the past. Notwithstanding the same, the credit profile of the companies in this sector is expected to remain healthy.

The issue concludes with the regular features: monthly rating updates, upcoming ICRA events, and news features related to the company.

I hope you will find this newsletter useful and informative.

Best Regards

Anjan Ghosh
Chief Rating Officer, ICRA Ltd

 
 
  From ICRA Research
   
  Timely resolution of stressed steel assets under IBC to help reduce import dependency
 

Priyesh N Ruparelia The domestic steel sector has turned out to be one of the major beneficiaries of the Insolvency and Bankruptcy Code (IBC). Out of the 40 large defaulting accounts identified by the Reserve Bank of India (RBI) in June and August 2017, 11 entities belong to the steel sector. As per the ICRA report, eight out of these 11 companies have steel manufacturing capacities totalling about 23.8 million metric tonnes per annum (mtpa), forming about 18% of the total domestic steel capacity.

The steel sector has provided an impetus to the IBC with four large corporate debtors having already completed the corporate insolvency resolution process (CIRP), yielding a resolution plan. The financial creditors have realised close to ₹ 444 billion from the CIRPs of these companies, with an average haircut of about 47%. The realisation for the financial creditors would have been even higher, but for the delays seen in concluding the resolution process for two large entities, viz. Essar Steel Limited and Bhushan Power and Steel Limited, both of which have attracted interest from domestic and foreign entities. These two entities have been enveloped in legal wrangles with their CIRPs now having exceeded 500 days. We expect resolution process for both to be concluded some time in CY2019, which should help the financial creditors realise at least an additional ₹ 600 billion.

Steel-manufacturing entities from RBI’s list of 40 large defaulting accounts
Company Claims by FCs (₹ billion) Claims realised by FCs (₹ billion) Haircut (%) Capacity
(million tonnes per annum, mtpa)
Remarks
Bhushan Steel Ltd 560 356 36 5.7 Acquired by Tata Steel Ltd
Essar Steel Ltd 492 NA NA 10.0 CoC-approved resolution plan submitted; NCLT approval awaited
Bhushan Power and Steel Ltd 473 NA NA 3.0 JSW Steel recently received letter of intent from Committee of Creditors
Electrosteel Steels Ltd 132 29 78 1.5 Acquired by Vedanta Ltd
Monnet Ispat & Energy Ltd 110 24 78 1.5 Acquired by JSW Steel-Aion Investments consortium
Visa Steel Ltd NA NA NA 0.5 Under litigation; Court stay order in place
Jayaswal Neco Ltd NA NA NA 1.0 Under litigation; Court stay order in place
Uttam Galva Metallics Ltd 36 36 0 0.6 Withdrawn from process after repayment of pending dues
Total 23.8  
Source: ICRA research; FC: Financial Creditor, CoC: Committee of Creditors

Further, as per the ICRA note, the steel sector turnaround over the past couple of years, following the imposition of trade remedials like minimum import price and anti-dumping duty on certain steel products by the Central Government, along with the increase in international steel prices, has been crucial in reviving bidders’ confidence. The stressed assets in the sector make for good candidates for acquisition by other large players who are looking to improve their market share and cater to the favourable domestic demand. Acquisition of these debt-ridden companies would provide stronger entities with operational plants that would immediately contribute to their operating profits, compared to the setup of a greenfield project, which typically would have a gestation period of three to four years at least.

As per ICRA estimates, the combined plant utilisation of the stressed assets was about 72% during FY2018. With successful acquisition of these assets by new promoters under the IBC, the capacity utilisation could be ramped up to 90% within the next two-year period, which would improve the domestic supply position.

It is assumed that the domestic steel consumption is likely to grow at a CAGR of 7% during FY2019-FY2022 period, in line with the healthy demand growth in FY2018 and in the current year, the requirement of steel in India goes up from 91 mt in FY2018 to 119 mt in FY2022, implying incremental volumes of around 28 mt. Now, even if the upcoming capacity expansions of about 19 mt, announced by the existing players to come onstream at 90% capacity utilisation, is considered, there would be a supply deficit of about 10.9 mt, which would have to be met through imports. The import requirement, therefore, would be significantly higher than the levels seen in the recent years, with 7.5 mt of steel imports reported in FY2018.

In such a scenario, the improvement in capacity utilisation of the stressed assets to 90% levels would help reduce the steel supply deficit to 6.6 mt from 10.9 mt in FY2022. Hence, we feel that successful resolution of stressed steel assets under the IBC mechanism would be crucial to contain India’s dependence on steel imports in the medium term,” concludes.

  Mixed bag for corporates: Revenue growth a positive but rising costs hit margins
 

Shamsher Dewan The results released by 648 companies in the Indian corporate sector shows revenue growth of 17.3% YoY in Q3 FY2019. The results in ICRA’s sample indicated that sales growth was stronger in the commodity-linked sectors (iron and steel, oil and gas and cement) and the consumer-oriented sectors (FMCG, consumer durables and airlines). The commodity-linked sectors posted 27% top-line growth on a YoY basis, supported by higher oil and steel prices, and healthy demand for cement. Excluding commodities, revenue growth for the rest of the sample was 13.3% YoY, in line with the growth in the previous quarter.

Although revenues grew at a healthy pace in Q2, the aggregate EBITDA margins declined by 75 bps on a YoY basis and 20 bps on a QoQ basis to 16.4% because of the rise in energy and raw material costs as well as the adverse impact of the rupee depreciation. While sectors such as airlines, cement and building materials (tiles and glass) reported a decline in EBITDA margins because of a sharp increase in fuel prices, sectors such as automobile OEMs, consumer durables, paints and media (newsprint) also saw margin contraction because of the rising input costs.

However, there were some positives towards the latter half of Q3 FY2019, such as a decline in global crude prices and price hikes by some sectors, leading to a sequential improvement in the EBITDA margins of airlines, tiles and ceramics and cement.

In terms of sector-specific trends, results in consumer-oriented sectors were mixed. While the automobile sector reported weak volume growth, other consumer-oriented sectors, especially consumer durables and FMCG, continued to witness an increase in the same. Within the automobile sector, the passenger vehicle segment registered a YoY decline of 0.8% in domestic sales in Q3 FY2019 because of high base and weak customer sentiments. Rising ownership costs (fuel, EMIs and insurance) partly contributed to the decline as well. The two-wheeler (2W) segment reported a sequential improvement in volume growth to 8.4% in Q3 FY2019 compared to 4.9% in the previous quarter.

The narrative on rural demand continues to be stable, with most companies reporting that rural growth outpaced the urban, although not by a substantial gap. Most of the companies expect the rural growth momentum to remain stable, supported by the potential hike in minimum selling prices (MSPs) and the overall thrust on agri-economy, ahead of the elections.

The IT sector reported healthy revenue growth of 8.3% (in dollar terms), supported by continued traction in digital offerings and improving momentum in banking, financial services and insurance (BFSI). The EBITDA margins remained flat on a YoY basis as benefits of the rupee depreciation were offset by an increase in sub-contracting costs and continued investments in digital technology.

With pickup in construction activity and new order inflows, the domestic steel and cement consumption were also healthy in Q3 FY2019, up 8.4% and 12.9%, respectively. While steel companies reported a 16.9% EBITDA margin (up 120 bps on a YoY basis), increase in pet coke prices and logistics cost led to a 30 bps decline in EBITDA margins of cement companies to 15.2%.

The airline sector saw a sequential improvement in financial performance supported by higher ticketing yields. The trend in higher yields has continued into Q4 FY2019 and the sector will stand to benefit from the decline in aviation turbine fuel (ATF) prices in this quarter.

  Indian auto components’ aggregate revenues likely to rev up 10-12% between FY2018 and FY2022
 
Subrata Ray

The Indian auto component industry has grown at a healthy CAGR of around 8.3% (from FY2014 to FY2018), driven by a steady demand from the OEMs, aftermarket (replacement market) and exports. The industry’s aggregate revenues have grown from ₹ ~2.32 lakh crore to ~ ₹ 3.45 lakh crore (Source: ACMA). As per ICRA’s comprehensive presentation note, titled ‘Indian Auto Component Industry, the Way Forward,’ the growth trajectory of the ancillary universe, which broadly tracks OE growth, is likely to be higher than the underlying automotive industry growth.

In terms of composition of the auto component industry, passenger vehicle (PV) and two-wheeler (2W) components account for about two-thirds of the OE consumption (including imports) by value. The industry primarily exports to Europe, which accounts for 34% of the exports followed by the US at 23%. As for imports, mostly Indian imports comprise child parts and sub-components, from Europe, which is the largest source market with a 30% share, followed by China, with a 27% share.

Over the next three to five years the demand for components is likely to grow by 9-11%. The OEM demand for components would be supported by the increasing localisation by the OEMs, and higher component content per vehicle. Indian exports have grown at a CAGR of 7% over the past five years ending FY2018. Future export growth will depend on global demand for vehicles and Indian inroads into newer products and global platforms.

ICRA notes that currently there is a significant gap between the Indian component manufacturers and global peers – in terms of scale and product complexities. However, as Indian emission and safety requirements tighten sharply in the coming years, this gap should gradually reduce.

As per estimates by the Society of Indian Automobile Manufacturers (SIAM), an investment of ₹ 1 lakh crore is required for upgrading to the BS VI standard, with 30-40% acquired from component manufacture. The past three years has already seen high investments for supporting new products and capacities and this is likely to continue to evolve and grow with the changing regulations. Capital expenditure by the auto component industry is likely to stay at ~7-8% of sales over the next three years, compared to 4-6% of sales for the global majors. However, the credit profile of the Indian auto component suppliers is healthy with sizeable liquidity to support capex.

For the Indian auto component industry to grow, a supportive policy framework is critical as are incentives for R&D investments and a supportive framework for electric vehicle transition. A clear roadmap and continuation of the Faster Adoption and Manufacture of - Hybrid and Electric Vehicles (FAME) scheme would help the industry firm up its own electric powertrain investment plans.

For revenue forecasts, the Indian auto component industry is likely to post healthy revenue growth in FY2019, driven by higher realisation and increased content per vehicle. As per ICRA estimates, the industry revenues are estimated to grow by 10-12% between FY2018 and FY2022 while the average industry operating margin ranges will be 13.5%-14.5% over the near term. Buoyed by low leverage and strong accruals in Indian operations, tier - I suppliers are exploring inorganic growth for technology and customer acquisition.

The credit ratio of ICRA’s rated portfolio of auto ancillaries has improved with upgrades surpassing downgrades for the sixth consecutive year, YTD FY2019. The industry outlook is Stable despite the heightened capex requirements and the pressure from emerging technologies.

ICRA mentions that the industry is currently in the midst of a technology transformation. Development of new emission technologies and safety norms would entail significant incremental investments and a ramp up in R&D or technology sourcing. The ICRA report also states that regulation-driven demand for safety features is leading to increased cost of safety. While this will eventually reduce with scale economies, increasing localisation will be a key challenge.

It is estimated that the electronic content in vehicles will reach 25-40% by 2030, driven by safety, emission and technological disruptions like connectivity. The shift to the BS VI norms will also lead to a rapid increase in demand for vehicle electronics. Currently, the Indian auto electronics space is dominated by global technology majors with a few Indian players. The challenge for Indian component manufacturers would be increasing localisation as import content in electronics is at present high at 60-70%.

As manufacturing platforms consolidate, commonality (usage) of parts will provide scale benefits to component manufacturers, however, this would give rise to sizeable investments in capacity creation.

Navigating complex and changing competitive landscape would require auto ancillaries to adopt a multi-pronged approach. Subsequently, the OEMs are increasingly opting for modules and sub-assemblies as against manufacturing individual components. Vendor rationalisation through increased tierisations is emerging wherein Tier 1s (and the OEM) have to ensure that the downstream supply chain is capable of supporting their demand. Therefore, the Indian ancillaries’ ability to transit to module and system suppliers and compete with deep-pocketed and technology-rich global majors will matter.

The industry would need to commit significant resources for these emerging technologies and simultaneously navigate investments in current businesses. The interplay between emission, electrification, safety and electronification is expected to increase the use of electronics in vehicles. Focus on localisation of components and technologies is a key area of investment for the industry. This would require a higher R&D to sales spend for Indian ancillaries. The average R&D/sales for top global majors is ~7% as against sub 1% for India. Further, the capex would have to stay consistently high at 7-8% of sales over the next three years as witnessed during FY2016-2018.

     
 
           
 
   
Rating Updates for the month of February 2019
   
Upcoming Events
March, 2019: Webinar on Trends and Outlook on Indian Renewable Energy Sector
March, 2019: Webinar on Indian Roads Sector
March, 2019: Webinar on Indian Healthcare Sector: Trends and Outlook
Business Standard: 18th March, 2019: Large Fund Infusions In Psbs Fail To Deliver
Business Standard: 16th March, 2019:Reduced NPA to drive solvency of PSBs, says ICRA
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