setco automotive ltd share price Management discussions

Economic Outlook

India?s GDP grew 8.7% in FY 2022 after contracting 6.6% during the previous fiscal which is one of the best in the world. India?s economy post major setback during FY21, as an aftermath of spread of Covid Pandemic went on V shape recovery and expected to grow >7% in FY2023. The economic activity in India has witnessed a sharp recovery to pre-pandemic levels on the back of a rapid and widespread rollout of the vaccination programme. A strong digital ecosystem, fiscal and monetary policy and various government schemes helped small and medium enterprises and the worst affected sections of the population to survive while reviving demand and bringing the economy back on track. However, the war between Russia and Ukraine raised supply chain disruptions across the globe including India resulting in infl ationary pressure and the consumer demand. Automotive Sector which was severely hit post aftermath of Covid-19 also went on V shape recovery with supply chain issues coming in control. The Automotive sector fi nally coming out of stress and stabilising the introduction of BSVI during the lockdown resulting in higher price to the end user.

Global supply chain disruptions due to pandemic-induced lockdowns have been replaced by new disruptions caused by the war in Ukraine and the economic sanctions, resulting in Infl ationary pressure. US Fed rates have been on increasing trend in order to control the infl ation which is on 4-5 decade highs.

During the second half of FY2021-22, OEMs continued to witness a pre-covid level demand and hence improved sales and is on increasing trend on account of the proposed spending on Infrastructure and rural segment promoting investment and industrial development and improving the business climate.

The outlook for current fiscal is positive.

Automobile Industry

Demand for passenger vehicles and commercial vehicles particularly MHCV reached the pre-covid level during second half of 2021-22 although its only about 50/55% of peak levels of FY2019. The adoption of BSVI coupled with headwinds in the RM prices specially the steel prices resulted in higher price to the end consumer although the pass-on was partially consumed by Industry thereby impacting profitability. MHCV truck industry grew on account of Economic growth and Infrastructure and Construction Spending, the Government of India?s bullish position on highway and infrastructure construction has been a vital cog in the MHCV industry?s growth over the last few years and will continue to grow. Some estimates and reports says MHCV industry to grow @17% CAGR for the next five years. Government policies will play a vital role in MHCV growth: After successfully deploying BS-VI emission norms, the next step in the government?s plan to further clean India?s MHCV fleet is two-pronged. First to ensure the new vehicle?s adherence to stringent emission and efficiency norms and to this effect, the second phase of corporate average fuel efficiency (CAFE) norms is slated for an April 2022 roll-out. The second step is to lower the existing fleetemissions by taking old and polluting vehicles o the road. This is where the recently announced scrappage policy comes into the picture. Scrappage Policy: India, by 2022, will have more than 6,80,000 end-of-life i.e. greater than 15 years old MHCVs on the road. These vehicles not only are highly polluting but also abysmal in terms of safety. The policy, which starts rolling out soon, will thus serve a ‘two birds with one stone? purpose for the government by not only reducing vehicular pollution but also by pulling unsafe vehicles o the road. The scrappage policy will also reduce OEMs? capital costs by way of recycling metal and other materials and increase the demands for new vehicles.

The Company?s performance was severely affected by Covid and slow down during first half of FY 21-22, resulting in cash flow pressure as an aftermath of cash losses, but fund raising in a timely manner resulted in improved performance during the second half more particularly in the 4th quarter.

Transfer of Business under Slump Sale to Step down Subsidiary Setco Auto Systems Pvt Ltd

Due to the combined pressures on the account of the Covid and economic affect, company was going through a very tough time on the cash flows, it was imperative for the Company?s continued well-being and the continued operations in the ordinary course that the Company re-finances its long term and short-term borrowings and other liabilities and secures additional working capital and growth capital to cater to the business requirement for increase demands.

The management is bullish about the overall long-term outlook of the Company and believes that there is a huge untapped potential in the business of the Company. The management also believes that the demand in the automotive sector has already picked considerably in the last few months and will further rebound in the coming months in the manner that it will o set any past losses due to pandemic etc. However, since the Company?s finances have been constrained, it has not been able to meet the market demand and therefore was in need of additional capital in the coming future, to create sufficient production capacity for catering to its customers. With a view to achieving this, the Company has in FY 21-22, undergone a financial restructuring to unlock value of the Company?s clutch manufacturing business as well as place itself on a much faster growth path. The Company has issued unlisted Non-Convertible Debentures worth Rs. 350 crores to schemes of the India Resurgence Fund managed by India Resurgence Asset Management Business Private Limited ("IRF") in the month of September 2021.The funds have been utilized inter alia to repay dues to all existing lenders including working capital lenders. Portion of the funds have also been utilized to meet overdue statutory liabilities and pressing creditors.

Simultaneously, with a view to unlock the value, the Company has executed a Business Transfer agreement on 31st August 2021, whereby the Company has transferred its clutch manufacturing business ("Clutch Business") (including all assets and liabilities pertaining to the Clutch Business, excluding inter alia the Company?s investment in its subsidiaries (including Lava Cast Private Limited, which is engaged in the business of manufacturing and supplying machined ferrous castings) and associate companies, and guarantee obligations of the Company), to Setco Auto Systems Private Limited ("SASPL") a step down subsidiary of the Company. The transfer of the Clutch Business to SASPL will have the effect of ring-fencing the valuable Clutch Business from the other liabilities and obligations of the Company, and therefore have positive impact on the revenues from the Clutch Business which to an extent were being diluted while being retained in the Company. The ring-fencing will make SASPL an attractive vehicle to raise both debt and equity funding required for the future growth and expansion of the Clutch Business. Consequently, SASPL was able to raise debt funding through issuance of listed non-convertible debentures for an amount aggregating to Rs. 215 crores from IRF. Simultaneously, SASPL was also able to raise equity funding for an amount aggregating to Rs. 50.00 crores against issuance of equity shares and certain convertible instruments which resulted in subscription of 35% shareholding of SASPL by the schemes of the India Resurgence Fund managed by India Resurgence Asset Management Business Private Limited. The management is of the view that with the aforesaid restructuring, the Clutch Business is well poised to be on a growth path which would result in creation of significant value for the stakeholders and will have huge long term positive impact on the prospects of the said business and therefore the Company and the entire Setco Group.

BS VI Clutch

The Company has transitioned to BS VI clutches fetching higher prices, so that all the new set of products meets the challenging requirements of future vehicles. The BS VI transition is a welcoming change from the perspective of greener and cleaner environment. The Company is sure that significant achievements would further reinforce and alter the product portfolio in future to meet modern automotive needs. With the efficient engineering, and the drive for innovation, design and technology, the Company will continue this domination, going forward.

Original Equipment Manufacturer (OEM)

During FY22, our OE Segment contributed 45% of the total revenue and growth was better than the industry due to implementation of Higher Axle load notification and BS VI norms has resulted in CV manufactures to come out with products with higher power and higher load-carrying capacity. The clutch products used in this model of CV is of bigger size resulting in higher realisation for us.

Replacement Market

The company?s aftermarket business comprises two segments; sales of clutch assemblies and service kits through the service and spare sales network of Original Equipment Spares (OES) and sales to the Independent aftermarket (IAM) network of distributors/dealers and local garages under ‘LIPE? brand. Aftermarket is a vital part of Company?s plan. As a strategy, the aftermarket, being a more profitable segment, was carefully developed and nurtured over the years. In FY 22, the after market segment constituted almost 55% of the revenue. The segment ensures not only sustainable growth but also decreases the vulnerable nature of the industry due to cyclical OEM demand. The already-peaked OEM cycle in the past is expected now to boost the aftermarket replacements, coming up from FY23 onwards. Though the Aftermarket Demand for both OES and IAM were there, the company had been facing challenges in increasing top line because of production constraints.

During the lockdown period of COVID-19 pandemic, the Aftermarket channel (OES & IAM) partners (distributors and retailers) continued to work and deliver the parts to the workshops for the urgent repairs of the vehicles transporting the essential supplies.

Farm Tractor Market: An Agriculture-driven Economy:

India is the biggest producer of tractors and are producing more tractors than commercial vehicles if you take only the medium and heavy vehicles into account. Interestingly, tractors that are being manufactured today have a powerful engine with high horsepower and accordingly, they need new types of clutches. Thus, there is a shift or even a vacuum in the market and we are entering that space and expect to reap a good growth, from both OE and aftermarkets.

At Setco, OE supplies started with two OE farm tractor customers from second half of FY22. Production ramp-up is in place to meet these OE requirements. Additional new customers? requirements are getting focused to cater to the growing segment demand now. Extension on this important agriculture segment which is the backbone to the Indian economy is part of the growth story at Setco. Continuous R&D efforts have resulted in the development of advanced farm tractor products within a short span of time with the focus on efficiency and productivity to drive business growth.

Presently, the facilities are equipped to meet the projected surge in demand for new tractors with minor capex, manufacturing capacity expansion, introduction of new tractor models as well as technologies and growing international sales.

International Business

The company has always laid special emphasis on its international markets through its overseas subsidiaries as it considers international business opportunities as an important growth driver for the company. The three strategically located overseas subsidiaries which cover the European, North American and Middle Eastern market are an integral part of Setco Group, and the Company believe that its presence will help to achieve its growth vision.

Despite the challenges and uncertainty in the current economic environment; the Company remain very optimistic about the growth and future.

Setco Automotive (UK) Ltd – SAUL

While SAUL has been an integral part of the Setco Group as a Research & Development hub for the company it has also served as a marketing face in the European Continent. SAUL has been promoting Company?s LIPE brand of clutches across Europe. Sales grew by 19% over last year. EBITDA was still negative, however, taking proactive steps the management has implemented many internal measures to reduce costs and set up some new distributors to be able to capitalize on this in the coming years. Company?s European presence remains one of the key growth drivers for Setco Group.

Setco Automotive (NA) Inc. – SANAI

The North American market is a lucrative growth driver and the Company has always had a dedicated focus on the North American operations. Launch of new range of ASD clutches towards the second quarter of the financial year were very well accepted by the market and also saw good demand in the market. Though the supply chain disruption impacted the supplies from India. Sales grew by ~52% over last year with EBITDA margins at 6.2%. With supplies improving from India will result in more sales and in turn more profits. In addition, the Management has also implemented many internal measures to make the operation leaner which will also help in achieving the growth strategy for the American Markets.

Lava Cast Private Limited - LCPL

LCPL has been making cash losses due to lower capacity utilisation since inception and thus was unable to service the Debt obligation. The account was restructured by Bank of Baroda, which gives LCPL benefit of elongated repayment along with lower Interest cost. This restructuring was implemented just after the first wave of Covid The second and third wave has further impacted the business and the stress on cash flow resulted in maintenance issues. The management is confident of the turnaround of the Lava cast as the maintenance activity is getting completed in the current year and with right resources in terms of people and RM will change the loss making to profitability.

COMPANY?S OPERATING HIGHLIGHTS AND KEY FINANCIAL RATIOS FOR FY 2021-22

Financial Analysis	Rs. In Crs
Particulars	FY 2022*	FY 2021	YOY Change (in %)
Operating revenue	156.74	314.06	-50.1%
EBIDTA	-6.36	14.17	-144.9%
EBIT (Operating) Margin	-31.52	12.87	-344.9%
Profit Before Tax	-170.72	-96.29	-77.3%
Profit After Tax	-174.82	-105.15	-66.3%

*Clutch Business was transferred through Business Transfer Agreement dated 31st August, 2021 w.e.f 7th September, 2021 to its subsidiary i.e. Setco Auto Systems Pvt. Ltd.

Key financial Ratios
Particulars	FY 2022	FY 2021	YOYChange (in %)	Reasons for Change
EBIDTA Margin	-4.1%	4.5%	-8.6%	Because of sluggish market due to Covid19 and supply chain issues on account of strain in liquidity and the slump-sale of business to subsidiary on 7th Sep 2021, top line reduced by 50%. This has affected EBIDTA and EBIT margin
EBIT (operating) margin	-20.1%	4.1%	-24.2%
PBT Margin	-108.9%	-30.7%	-78.3%
PAT Margin	-111.5%	-33.5%	-78.1%
Debtors Turnover	0.02	0.04
Inventory Turnover	0	2.04
Interest coverage ratio	-	0.29
Current Ratio	0.69	0.47
Debt Equity Ratio	-	2.74
Return on net worth	-	-

SUBSIDIARIES OPERATIONAL HIGHLIGHTS

Setco Auto Systems Pvt Ltd

	Rs. In Crs
Particulars	FY 2022*
Sales	261.97
EBIDTA	22.00
Profit After Tax	-173.47

*Clutch Business was acquired through Business Transfer Agreement dated 31st August, 2021 w.e.f 7th September, 2021 from holding Company i.e. Setco Automotive Ltd.

Lava Cast Pvt Ltd

	Rs. In Crs
Particulars	FY 2022	FY 2021
Sales	45.00	38.22
EBIDTA	-16.19	-6.29
Profit After Tax	-36.73	-27.52

SETCO AUTOMOTIVE (UK) LTD

Particulars	FY 2022	FY 2021	FY 2022	FY 2021
	In GBP mn	In GBP mn	In INR Crs	In INR Crs
Sales	2.81	2.36	28.54	22.97
EBIDTA	-0.62	-0.56	-6.29	-5.48
Profit After Tax	2.71	-0.58	27.56	-5.67

SETCO AUTOMOTIVE (NA) INC

Particulars	FY 2022	FY 2021	FY 2022	FY 2021
	In USD mn	In USD mn	In INR Crs	In INR Crs
Sales	6.98	4.60	51.95	34.07
EBIDTA	0.43	-0.31	3.18	-2.31
Profit After Tax	1.85	-0.39	13.81	-2.92