Mahindra Ugine Steel Company Ltd Merged Management Discussions

COMPANY OVERVIEW:

Mahindra Ugine Steel Company Limited (MUSCO) is one of the leading manufacturers of Stampings products in India and caters to the automobile industry with a wide range of automobile stampings- products..

MUSCO manufactures stampings products like skin and non skin panels, chassis reinforcements, cross members, engine components etc. from its production units located at Kanhe, Nashik, Rudrapur and Pantnagar and these units are located near important automotive clusters in India. Majority of the revenue of the stampings business comes from the utility vehicle segments though the company has significant presence in the tractor, light commercial vehicles, passenger cars and three wheeler segments of the automotive market. Some of the largest automotive and tractor manufactures in India are the customers of the stampings products of the Company.

The manufacturing facilities at the stampings business of your company provide various services ranging from conceptualization to design, testing, and manufacture of stamping products. The core strengths of the business lies in tool design and development, and in providing value-added services like welded assemblies and finishing operations such as powder coating and electrophoretic deposition (ED) coating.

INDUSTRY STRUCTURE AND OUTLOOK:

Indian Economy

Economic growth in India eased to 4.6 per cent in the first three quarters of FY14 and the just-concluded financial year may log a lower growth rate than last year. Overall, the Indian economy had been exhibiting inflationary tendencies in the previous years and as a response the Reserve Bank of India (RBI) started raising policy rates from March 2010. High rates as well as policy constraints adversely impacted investment, and in the subsequent two years viz. 2011-12 and 2012-13, the growth rate slowed to 6.2 per cent and 5.0 per cent respectively.

The slowdown, especially in 2012-13, has been across the board, with no sector of the economy unaffected. With the global economy also showing signs of a sustained recovery in 2013, and the post elections improved sentiments should help improve economic conditions. The country is expected to grow for the next five years, due to a likely stable government post-elections.

Automotive Market

The target segments of the Company in India are the passenger car, utility vehicles (UV), Light Commercial Vehicle (LCV) & tractor markets. In the current financial year, the cumulative UV production has ^declined marginally by ~2% compared to the previous year. Similarly, the production of cars the cumulative passenger cars production has declined by 7.4% compared to the previous year. Overall, passenger vehicle (cars + UVs) production shrank marginally by ~4% compared to the corresponding period in the previous year. The cumulative LCV production fell even more sharply by approximately 14%. However, the Tractor industry production has shown a healthy 20% growth compared to the corresponding period in the previous year.

Leading auto industry analyst Crisil, expects the auto industry to return on to the growth trajectory in 2014-15, but this return to growth is expected to be gradual. Similarly they expect the LCV segment sales to remain sluggish for the first two quarters, and thereafter recover moderately.

In line with this we expect a slight growth in the overall passenger vehicles and LCV markets. The domestic tractor market is also expected to retain its growth momentum, even though Crisil expects the growth to slow down.

Performance

During the year under review the business of the Company; on the back of de-growth in Utility Vehicle, Passenger Vehicle and Light Commercial Vehicle segment, posted a negative growth in sales as compared to the previous year. The Farm equipment sector registered a good performance in the financial year under review, due to which the Company was able to fill the deficit of negative growth in the automotive sector to some extent.

In financial year 2013-14, the Stampings business had posted a negative growth. The key performance parameters are as follows:

• Sale of stampings & assemblies decreased from 69,318 tonnes in the financial year 2012-13 to 62,836 tonnes in the financial year 2013-14 posting a negative growth of 9%.

• Operating Income witness drop from Rs 766.39 crore recorded in financial year 2012-13 to Rs 723.02 crore in financial year 2013-14 posting a negative growth of 6%.

• Operating margin (EBIDTA) dropped from Rs 66.28 crore in financial year 2012-13 to Rs 56.84 crore in financial year 2013-14 mainly due to de-growth in Utility Vehicle, Light Commercial Vehicle and medium & heavy vehicle segment, in the year under review

Opportunities and Strategic Outlook

Your company operates in sheet metal components, assemblies and sub-assemblies, BIW segment of the Auto Components Industry. The demand for the auto components is directly related to the uptake by OEM’s. By all estimates the Indian auto industry will continue to grow, even though there has been a slowdown in the growth in recent quarters. The Indian auto components industry is thus well poised to achieve strong growth in the near term. The drive towards localization by many foreign car manufacturers in India, also presents an opportunity for Indian Auto component manufacturers.

According to the Auto Components Manufacturers Association (ACMA), the Indian auto components industry is likely to grow to US$ 110 billion by 2020 with the domestic market share of ~US$ 80 billion. The share of the auto components industry in the country’s GDP is likely to increase to 3.60% by 2020, up from 2.40% in FY12. Given good long term demand prospects in the domestic market and with India emerging as a favored low-cost sourcing destination, auto component manufacturers are likely to invest in increasing production capacities and technological capabilities. Your company is also looking to expand its manufacturing capacity to cater to the growing demand of automotive products from southern parts of India.

Furthermore, companies would continue to diversify their product portfolio to de-risk their businesses. However, competition is expected to increase and prices of raw material are likely to follow an upward trend. This is expected to exert pressure on the industry’s profit margins. In such a scenario, cost control programs would assume greater significance for the industry players, both big and small.

Threats and Risks

Indian auto components industry is poised to sustain its revenue growth momentum over the short to medium term. However, the industry profitability may face pressures due to; Pricing pressures from OEMs, which in turn are entering into a phase of heightened competitive intensity thus putting constraints on their pricing power

• Threat of rising commodity prices

• Likely higher cost of funds consequent to hardening of interest rates

• Import from other low cost locations

• Increasing trend towards light weighting vehicle design and aluminum components.

FINANCIAL PERFORMANCE:

The move towards stricter emission norms is also expected to lead to lighter weight auto components, smaller engines and greater usage of Aluminium and Plastics. The Company is conscious of this fact and many of its innovations are focused around lighter weight components and newer materials.

In addition companies engaged in select product categories within the auto components industry are expected to incur large capex for enhancing production capacities to meet the growing demand, which could affect the capital structure and return metrics of such companies over the short term. However, the anticipated strong business growth should result in healthy cash accruals and enable companies to tide over the short term pressures and emerge with a stronger over the medium term.

Other risks to growth and profitability of Indian component industry include increase in competition from other countries to capture business both in the international as well as domestic markets, uncertainty arising from currency volatility and, ability to acquire capabilities in tune with technological advancements. The industry efforts to mitigate the above risks along with policy measures of the government would determine the impact of the above risks on the auto components industry going forward.

In continuance with the details provided above, summary of financial performance of the Company is presented below:

Amount in (Rs.) crore

Particulars	Steel (including Bearing Races)*		Stampings		Total*
	April- Mar 14	April- Mar 13*	April- Mar 14	April- Mar 13	April- Mar 14	April- Mar 13*
Sales	-	224.44	723.02	766.39	723.02	990.83
Other Income	-	1.41	5.82	0.65	5.82	2.06
Total Income	-	225.85	728.84	767.04	728.84	992.89
EBIDTA	-	(5.41)	56.84	66.28	56.84	60.87
PBT	-	(25.26)	26.86	28.84	26.86	3.58
Exceptional items (loss on hive off) / profit on sale of land & investments	-	-	229.17	-	229.17	(47.00)
PAT	-		188.15		188.15	(33.72)

*Note: The figures of financial year 2012-13 for the Steel business are up to 9^th July 2012 being date of transfer of Steel business to the wholly owned subsidiary of the Company as at the closing hours of 9^th July 2012, on slump sale basis as a going concern. Accordingly, the figures of the financial year 2012-13 of the Company comprises of financials figures of the Steel business up to 9^th July 2012. Hence the financial figures of FY 2013-14 are not comparable with FY 2012-13.

The Mahindra – CIE Deal

On 15^th June 2013, Mahindra & Mahindra Limited (M&M) and CIE Automotive Group of Spain (CIE) got into an agreement to create one of India’s larger multi-technology automotive component companies.

Step 1:

- CIE has purchased controlling stakes in Mahindra CIE Automotive Ltd (MCAL) (formerly known as Mahindra Forgings Limited), Mahindra Composites Limited (MCL) and Mahindra Hinoday Industries Limited (MHIL) and is a majority shareholder after the closure of Open Offer of MCAL & MCL.

- Simultaneously, M&M has purchased an equity stake of 13.5% in CIE Automotive Limited, Spain. Therefore, M&M continues to be a strategic investor in the auto components business with participation in Mahindra CIE and CIE Spain (parent level).

- Effective 29^th November 2013, Mahindra Forgings Limited has been renamed as Mahindra CIE Automotive Limited.

Step 2:

MUSCO, MHIL, Mahindra Gears International Limited, Participaciones Internacionales Autometal Tres, S.L. (PIA3) and Mahindra Investment India Private Limited will merge in to MCAL through an integrated scheme of merger. MCL will merge into MCAL through a separate scheme of merger. This is expected to be completed by October 2014 subject to regulatory approvals. The structure of the deal is also indicative that M&M is reaffirming its commitment to the automotive components business.

The Rationale for the Deal

Both CIE and M&M have had a strategy to globalize their auto components business interests. This partnership will help both the groups in furthering that aim.

SYNERGIES WITH PARENTS:

In light of the deal with CIE, your company would benefit in a lot of areas. Some of the partnering process has already begun in the form of technological support for new products in existing materials.

Relationship with CIE Group

CIE group is a group specialised in providing automotive components and sub-assemblies to, to the global automotive industry, working with complementary technologies and a number of different associated processes.

With the active involvement of the CIE group, MUSCO intends to achieve the following synergies: CIE products and customers can be introduced in India.

1. Gaining Market Share in India with existing CIE customers (Western OEMs’ from global markets) and expanding into all the technologies which CIE operates in viz. Aluminium, Painting, and Plastics.

2. Improving operational efficiencies by using CIE’s expertise and enhancing the product offerings.

MUSCO will adhere to the corporate values, principles and established corporate governance practices of the CIE Group.

Relationship with Mahindra Group

Mahindra & Mahindra; which holds a majority stake in MUSCO, is the flagship company of the Mahindra group and one of the leading automotive manufacturers in India. M&M is an anchor customer but there is an arms-length relationship between M&M and MUSCO. Association with the Mahindra Group aids MUSCO in winning new businesses due to higher brand recall and obtaining financial assistance, whenever required.

SAFETY, HEALTH AND ENVIRONMENT:

The Company has an effective policy framework; on Safety, Health & Environment (SHE) for protecting the safety, health and welfare of its employees and workers. The Company accords sufficient priority to the objectives of preserving and developing the environment, maintaining a safe work place, enhancing the quality of the work conditions and health aspects of its employees. The company’s SHE policy not only meets all applicable statutory requirements but also focuses on motivation, learning and training of employees. The process defined under the SHE Policy ensures leadership from the top management for improving safety, environment and health aspects in operations while laying down norms. It also lays down norms for participation from across the management and workforce hierarchy. External audits are conducted to ensure effectiveness of the SHE policy and initiatives and recommendations are considered for further improvements in SHE process. SHE issues are addressed proactively and effectively in terms of ISO standards and guidelines. The Company plant at Rudrapur received ISO 14001 and OHSAS 18001 certificates. The Kanhe and Nashik locations received (EMS) ISO 14001: 2004 and OHSAS 18001: 2007 certificates.

The Company accords the highest importance to adopting safety measures for preventing accidents. In case of any accident, a thorough investigation is carried out to identify the root cause and immediate steps are taken to eliminate the root cause to ensure it does not recur. The Company regularly conducts counselling and safety review meetings for employees to appraise and educate them on the adoption of safety measures and avoidance of unsafe practices. Awareness and first aid trainings are conducted regularly along with mock drills as an exercise in disaster management readiness. The Company is in compliance with the regulations pertaining to safety. The objective is to achieve zero accident, zero incidents and a safe work environment.

The Company periodically conducts health checkups and health awareness programmes, First Aid training given by Govt. authorized institutes for all employees and if necessary provides prompt medical assistance to its employees. The Company has an internal plant dispensary which operates round the clock and is manned by qualified doctors supported by staff who are available for addressing health issues of employees. The Company maintains high hygienic and housekeeping standards across the work places. The goal of all occupation health and safety measures is to encourage a safe work environment.

MATERIAL DEVELOPMENT IN HUMAN RESOURCES / INDUSTRIAL RELATIONS:

The total employee strength of the Company at the end of the financial year 2013-14 was 997 employees comprised of 383 Officers and 614 permanent workmen and employees. Apart from above employee strength, the Company hires Apprentice, Trainees and Contract workers from time to time.

The Company conducts regular training programs for officers and workmen through internal and external professionals, experts in various areas of operations and selectively sends officers to attend Business Education Programs of reputed Institutions to improve their skills and knowledge.

The Company involves its employees in all HR Activities to develop them and recognize them from time to time to increase the Employee Morale and Motivation. The Human Resources policies are comprehensive and based on the best of the prevailing HR practise. The performance evaluation and management process continues to be the backbone of all HR activities and is based on an appropriate goal-setting process. The Company encourages all employees and workers to participate in a fair and transparent feedback system called "Bindass Bol" (talk candidly) for sharing views, concerns and opinions.

The Company has rolled out a Policy for prevention of sexual harassment in which it formalized a free and fair enquiry process with clear timeline. The Company has also constituted an internal complaint committee at major location to which employees can write their complaints. There was no case/complaint reported under the Sexual Harassment of Women at Workplace (Prevention, Prohibition and Redressal) Act, 2013 during the financial year 2013-14. The relationship of the Company with its Human Resources was cordial in the financial year 2013-14.

INTERNAL CONTROL SYSTEMS AND THEIR ADEQUACY:

Your Company has adequate internal controls for its business processes across departments to ensure efficient operations, compliance with internal policies, applicable laws and regulations, protection of resources and assets, and accurate reporting of financial transactions. The Company also has an internal audit system which is conducted by an independent firm of Chartered Accountants/Consultants so as to cover various operations on continuous basis. Summarized Internal Audit Observations/Reports are reviewed by the Audit Committee on a regular basis. The finance and accounts functions of the Company are well staffed with qualified and experienced members. The internal controls are complemented, on an on-going basis, by an extensive program of internal audits being implemented through-out the year. The Company uses an Enterprise Resource Planning (ERP) package, which enhances the internal control mechanism. The internal controls are designed to ensure that the financial and other records of the Company are reliable for preparing financial statement and other data for maintaining the accountability of assets.

Looking Ahead

With continued support of its parents the Mahindra and CIE groups, your company will continue to strive for improved financial performance. The Company also recognizes the long term trend towards growth especially in India, and will continue to look out for and evaluate opportunities in this direction.

Cautionary Statement

Certain statements in the Management Discussion & Analysis describing the Company’s objectives, projections, estimates, expectations or predictions may be "forward looking statements" within the meaning of applicable securities laws and regulations. Actual results could differ from those express or implied. Important factors that could make a difference to the Company’s operations include raw material availability and prices, cyclical demand and pricing in the Company’s principal markets, changes in Government regulations, tax regimes, economic developments within India and the countries in which the Company conducts business and other incidental factors.