Elecon Engineering Company Ltd Management Discussions.

Global Economy and India

Global economy growth is estimated to have contracted by 3.3% in 2020, the worst performance after the great depression due to the Covid-19 pandemic which disrupted normal economic activity. Trade and manufacturing were severely impacted and there was sudden drop in demand. However, the economy witnessed meaningful recovery in the second half of the year on the back of lifting of restrictive measures by governments across the world and favourable fiscal and monetary support by central banks around the world which helped in averting a full-blown recession. Increase in exports, residential and non-residential investment, consumer spending, and inventories contributed positively to the growth in the later part of the year. According to IMF, global growth is projected to increase by 6.0% in 2021 led by vaccine powered uptick and policy support in major economies of the world. Additional fiscal support in the US and Japan and other major economies of the world along with relaxation in restrictions raises the likelihood of economic recovery. However, renewed lockdown due to increase in cases, financial stress and geopolitical tension could derail the slow and gradual recovery. As such, concerted worldwide effort is needed to stabilize world trade and ensure sustainability of recovery.

The Indian economy which was already facing slowdown was hit hard by the Covid-19 pandemic and subsequent nationwide lockdown. There was sharp decline in manufacturing and exports, capital flows and remittances, and severe disruption in supply chain amid strict economic lockdown. Recovery in the second half of the fiscal year on the back of relaxation in restrictive measures mitigated the overall decline in the economy leading to a contraction of 8.0% in FY21. The policymakers announced substantial fiscal and monetary stimulus to revive the economic growth engine. Moreover, government announced production linked incentive (PLI) schemes to boost the domestic manufacturing sector and increased spending in infrastructure sector to kickstart growth. According to IMF, the Indian economy is expected to grow by 12.5% in FY22 making it the only major economy in the world to register a double-digit growth. The growth is expected to be led by increased economic activity supported by widespread vaccination. Pick up in private consumption and business investment is expected to boost demand and spur economic activity. However, strengthening second wave of Covid-19 remains major headwind to recovery.

The Engineering Sector and Gears

The Indian Engineering sector plays an especially important role in the overall economic growth of the country as it drives the growth of core sectors of the Indian economy. Historically, India’s engineering export portfolio has been skewed towards low- and medium-technology intensive engineering goods. However, increased adoption of digital technologies in manufacturing is likely to alter the engineering exports landscape. India’s engineering exports which had been concentrated more towards USA and EU has been fast shifting towards emerging economies such as SAARC, ASEAN, Africa, CIS, and Latin America. The country’s export potential is immense and there exists opportunity to attain leadership across various product categories. Although the sector has been impacted due to Covid-19 pandemic, the recent tax reforms to revive the domestic capex cycle and introduction of production linked incentive (PLI) schemes is likely to positively impact companies in the industry by raising their global competitive advantage and would help India become a manufacturing hub as it would boost new investments into the manufacturing sector. Along with this, Government’s ongoing thrust on infrastructure development is expected to be major positive for the industry. The government’s move to improve intellectual property rights is a welcome step for the engineering and technology services. Global industrial gearbox market is expected to grow at a CAGR of over 5% between 2020-2025 driven by increasing level of automation across industries and increasing adoption of energy-efficient and high-performance gearboxes. Ongoing investments by the government and the private organizations in the end-user industries such as material handling, power, and metal and mining sectors are propelling the growth in the industrial gearbox market. Additionally, growth in construction industry in developing nations should boost the global industrial gearbox and industrial gearbox service market.

Elecon Engineering - Company Review

Fiscal 2020-21 witnessed average performance due to the Covid-19 pandemic. The Material Handling business saw muted performance under challenging environment. Reduction of debt and customer receivable continued to be one of the main focus of the Company. Also, considerable effort was directed towards streamlining of existing operation with a focus on cost rationalization to counter the headwinds posed by slowing economy.

The Company’s gear business witnessed satisfactory performance on the back of modest order inflows and favourable product mix. Considering the slowdown in the economy which negatively impacted performance, the Company undertook restructuring and cost control initiatives. The performance in the MHE business was negatively impacted owing to losses from past projects. However, significant improvement in profitability is expected over time owing to past restructuring efforts aimed at taking only profitable product business. The turnaround in the MHE business is likely to improve overall profitability once there is revival in the economy. The Company’s performance in gear business was heartening considering sagging demand environment while the performance in MHE business was subdued due to past loss-making projects. The management undertook several cost reduction and product upgradation initiatives to counter the slowdown. The Company is well poised to capitalize on the upcoming opportunities as and when there is uptick in the demand cycle. Manufacturing activity which had been impacted due to the Covid-19 pandemic has now reached pre pandemic levels. The Company remains well prepared to tide over the slowdown and seize opportunities as and when they arise.

Segment Wise Revenue - Gear Business

India’s power sector is undergoing a positive change. The government has introduced key reforms in the sector with an aim to maximise power generation capacity, improve distribution and promote investment in order to realise its goal of 24X7 electricity for all. Recent announcement of Rs 3.05 trillion scheme to revive power distribution companies and enhance overall efficiency in the power distribution sector is a key positive. Government’s focus to replace all conventional energy meters by prepaid smart meters is likely to strengthen the efficiency of the T&D infrastructure, help reduce AT & C losses, thereby leading to improvement in the financial health of DISCOMS. Likewise, the expansion of ‘PM KUSUM Yojna’ will boost the solar power generation in the country. Furthermore, announcements of lower corporate tax for new energy companies is likely to attract new investments in the sector thus accelerating India’s push towards becoming a power surplus country. All these development augurs well for Elecon’s business in power generation, distribution, transmission and equipment.

As the country prepares to realize the goal of becoming a five trillion-dollar economy by 2025, the government extended its Rs 111 lakh crores National Infrastructure Pipeline to invest in energy, road transport, civil aviation, shipping, telecom, power & mining, railways and housing and urban development and revive economic growth. Also, the government approved a capital infusion of Rs 6,000 crore in the National Investment and Infrastructure Fund (NIIF) for much needed spending in infrastructure projects. The government’s infrastructure investment plan will create incremental demand for the sector in the coming years. High allocation towards rural housing and infrastructure, plans to set up new smart cities and 100 airports by 2024 to support UDAN scheme will act as a key catalyst for industry growth. India is currently the world’s second largest producer of crude steel. According to the Ministry of Steel, the steel industry contributes around 2% to the GDP of the country. Fresh investment by government in the development of highways, ports, airports, railways, and power along with focus on automobile sector augurs well for the growth of the sector. Huge scope for growth is offered by India’s comparatively low per capita steel consumption and the increasing demand for affordable housing. Increased allocation towards infrastructure spending and projects like industrial corridors, Sagarmala, and Smart Cities initiatives will boost the consumption of steel. As such, companies in the steel industry are likely to continue spending to expand their capacity. India enjoys a coastline of approximately 7.5 thousand kilometres and has a unique maritime position. With around 199 ports including 12 major ports that handle approximately 1,400 million tons of cargo each year, the maritime transport accounts for majority of India’s trading in value terms. As such, the Indian ports and shipping industry plays an indispensable role in the country’s trade and commerce and occupies a vital potential position in India’s economic growth. The Indian government continues to focus on port modernization and new port development, port connectivity enhancement, port-linked industrialization, and coastal community development under the Sagarmala project. Major inland water transport projects are under construction as an alternative to road and rail routes to transport goods to the nation’s ports. Also, the government is encouraging private participation to strengthen the ports, shipping and waterways sector with an aim to capitalize on the geographical presence advantage, attract higher foreign direct investment and develop India as a trans-shipment hub. India’s domestic sugar industry is going through transformational change as the government introduced favourable policies for the growth of the sector which include introduction of minimal selling price (MSP) for sugar, increase in the ethanol blending programme, export subsidy and soft loans to set up distillery. The additional green field and brown field ethanol production capacities is likely to reduce sugar production and insulate the industry from market glut conditions. These steps will enable cash-strapped mills to liquidate surplus inventory and clear sugarcane arrears to farmers which augurs well for the industry. Recently, the government introduced modified scheme for extending interest subvention for those setting up grain-based along with molasses-based ethanol distilleries. All these measures augurs well for the industry.

Financial Performance

From a financial perspective, the total standalone operating income increased to 79,636.37 Lakhs for FY21 as compared to income of 83,573.82 Lakhs in the previous year. EBITDA stood at 15,486.40 Lakhs as compared to 11,460.37 Lakhs during the corresponding period of the previous year. The EBITDA margin increased by 35.13% for FY21 to corresponding period. Net profits stood at 3,626.49 Lakhs for FY21 as compared to 7,241.89 Lakhs in the previous year. At the consolidated level, the total turnover during FY21 was 1,04,470.65 Lakhs as compared to an income of 1,08,846.49 Lakhs in the corresponding period of previous year. At the EBITDA levels, it registered an EBITDA of 19,133.63 Lakhs as compared to 14,822.68 Lakhs during the corresponding period of the previous year. The consolidated EBITDA margin increased by 29.08% for FY21 to corresponding period. Consolidated PAT after share of profit of associates was at 5,763.10 Lakhs for FY21 as compared to 8,970.15 Lakhs in FY20.

Financial Ratios

Pursuant to Regulations 34 and 53 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015-

Particulars Standalone Consolidated
31.03.2021 31.03.2020 31.03.2021 31.03.2020
Debtors Turnover Ratio 1.55 1.51 1.87 1.81
Inventory Turnover Ratio 3.94 3.58 3.75 3.48
Interest Coverage Ratio* 2.25 1.02 2.52 1.29
Current Ratio 1.29 1.15 1.35 1.22
Debt Equity Ratio* 0.31 0.50 0.36 0.57
Operating Profit Margin 18.09 12.60 17.95 13.04
Net Profit Margin (%)* 4.55 8.67 5.52 8.24
Return on Net Worth(%)* 4.44 9.31 6.39 10.50

*There is a change of more than 25% in Interest Coverage Ratio, Debt-Equity Ratio, Operating Profit Margin, Net Profit Margin and Return on Net Worth ratios. Such change in Interest Coverage Ratio is mainly due to Improvement in PBT and reduction in Interest Cost. The Change in Debt Equity Ratio is mainly due to reduction in Total Debt and Improvement in Net Worth. Change in Operating Profit Margin is due to optimized use of inventory and reduction in manufacturing cost and few fixed cost. Change in Net Profit Margin and Return on Net Worth is due to deferred tax asset recognized in previous year on asset reclassification.

Risk and Concerns

The Company could be susceptible to strategy, innovation, and business or product portfolio related risks if there is any significant and unfavourable shift in industry trends, customer preferences, or returns on R&D investments. Elecon does have the benefit of being very well entrenched with many of its customers, involved in their critical and strategic initiatives. Therefore, client concentration related risks are mitigated to an extent. Risks emanating from changes in the global markets such as the recent financial meltdown, regulatory or political changes, and alterations in the competitive landscape could affect the Company’s operations and outlook. Any adverse movements in economic cycles in the Company’s target markets and volatility in foreign currency exchange rates could have a negative impact on the Company’s performance. This risk is mitigated to some extent due to the Company’s presence in multiple and diverse markets. The Company also takes necessary steps such as forex hedging to mitigate exchange rate risks. Elecon operates in a highly competitive industry, replete with multiple competitors, in both India and abroad. Shifts in clients’ and prospective clients’ dispositions could affect its business. While the Company has strong domain expertise, robust delivery capabilities, and significant project experience, there is no guarantee that it will always get the better of competition.

The Company’s operating performance is subject to risks associated with factors that may be beyond its control, such as the termination or modification of contracts and non-fulfilment of contractual obligations by clients due to their own financial difficulties or changed priorities or other reasons. Elecon does have mechanism in place to try and prevent such situations, as well as taking insurance cover as necessary.

Internal Controls System

The Company has mechanisms in place to establish and maintain adequate internal controls over all operational and financial functions. The Company intends to undertake further measures as necessary in line with its intent to adhere to procedures, guidelines and regulations as applicable in a transparent manner.

Internal Controls are continuously evaluated by the Internal Auditors and Management. Findings from internal audits are reviewed by the Management and the Audit Committee. The corrective actions and controls have been put in place wherever necessary. Scope of work of Internal Auditors covers review of controls on accounting, statutory and other compliances and operational areas in addition to reviews relating to efficiency and economy in operations.

Development in Human Resources/Industrial front

The Company has a strong committed work force nurtured and backed up by its professional culture coupled with innovative HR process aimed at strategic alignment with the business objectives. It has been the tradition of the Company to maintain excellent industrial relations at all levels. This has ensured that we have a committed and dedicated workforce with a high level of enthusiasm. The number of employees as on March 31, 2021 was 619 as against 772 as on March 31, 2020.

Outlook

The Indian economy is expected to rebound and attain a growth of 12.5% in FY22 on the back of improvement in trade and manufacturing against the backdrop of widespread vaccination campaigns. Responding to the recent pandemic crisis, the policymakers announced various fiscal and monetary stimulus to stimulate demand and revive manufacturing growth. As such, the Company remains hopeful of future growth prospects led by revival in core sectors such as power, steel, cement, and mining.