vardhman special steels ltd Management discussions

MANAGEMENT DISCUSSION AND ANALYSIS REPORT

Global economy

It was a year of economic resurgence.

The global economy rebounded smartly in 2021 after a traumatic 2020 during which it remained constrained by an invisible enemy. Global GDP climbed by 6.1% in 2021 against a 3.1% contraction in 2020. This resurgence was fueled by strong consumer spending, uptake in investment, additional fiscal support in large economies, anticipated vaccine-powered recovery and continued adaptation of economic activity.

As the world stepped into 2022, the Omicron scare raised alarm bells once again. But the scare was short lived. Even as the world was working to overcome the challenges of rising inflation and continued supply-chain disruption, the Ukraine-Russia crisis forced economists across the world to recalculate their estimates. The International Monetary Fund in its document dated April 2022, has reduced its global GDP growth estimates for both 2022 and 2023 to 3.6%. These numbers could undergo revisions as the war continues and its aftermath unfold.

Indian economy

India accelerated at a faster clip

After a catastrophic 2020-21, the Indian economy rebounded sharply to register a GDP growth of 8.7% in 2021-22 (as per the second advance estimate of the National Statistical Office (NSO)). The industrial sector is expected to register the highest growth of 11.8% followed by the services sector at 8.2% and the agricultural sector that improved its performance from 3.6% growth in 2020-21 to 3.9% in 2021-22.

19 out of 22 High-Frequency Indicators crossed their pre-pandemic figures – showcasing a holistic rebound. The ratings agency Moodys has changed Indias sovereign rating outlook to "Stable" from "Negative" and afirmed the countrys rating at "Baa3". Going forward, Indias GDP growth is expected to taper down a few notches owing to the geopolitical uncertainties. Taking cognizance of this reality, the Reserve Bank of India has projected a 7.2% GDP growth in FY23. The IMF has projected a "fairly robust" growth of 8.2% for India in 2022, making it the fastest-growing major economy in the world, almost twice faster than Chinas 4.4%.

The global and Indian steel space

The hot metal was in demand

Economic activity progressively improved during 2021 as lockdown measures eased. As a result, global crude steel production (based on the output in 64 countries that report to the World Steel Association) increased 3.7% in 2021 to 1,950.50 MT as compared with a 0.9% output drop in 2020. This growth was despite a drop in steel production by China, the largest steel producing nation in the world. (Source: https:// worldsteel.org/media-centre/ press-releases/2022/december-2021-crude-steel-production-and-2021-global-totals/)

The steel industry has done well. According to government data, Indias crude steel production stood at 120 million tonnes (MT) in FY22, which is a growth of 18% over the previous year. Steel exports also surpassed the FY21 level while imports continued to decline.

Going forward: According to the recent Worldsteel estimate, steel demand is expected to grow by 0.4% in 2022 to 1.84 billion metric tonnes. The stable recovery of the global steel sector has been adversely impacted owing to the Russia-Ukraine crisis and rising inflation. In 2023, it is going to see a growth of 2.2% to reach 1.88 billion metric tonnes. (Source: https://worldsteel.org/media-centre/press-releases/2022/ worldsteel-short-range-outlook-april-2022/)

The secondary steel segment

Todays modern world and human existence revolves around steel. Interestingly, much of the steel we use comes from the secondary steel sector. Because steel needs specific properties for particular applications – a job which is seamlessly managed by the secondary steel sector. The segment accounted for about 55% of Indias steel production about a decade ago but has fallen to about 40% in 2021-22.

The prospects for the secondary steel sector lie in addressing the opportunity offered by the current (low) level of per capita finished steel consumption in India. The Government is doing its bit to improve the prospects of the secondary steel segment. The Ministry of Steel is working on framing a policy framework for secondary steel on addressing their falling share in the total steel output.

The Indian government has announced a PLI scheme for the specialty steel industry for 5 years starting from 2023-24. The scheme is supposed to benefit both steel making giants as well as the MSMEs. This scheme is expected to draw investments of Rs.400 billion ($5.37 billion) and expand the capacity of specialty steel from 18 MT in 2020-21 to 42 MT in 2026-27.

The automotive sector

The acceleration was not as intense

The automotive sector displayed remarkable resilience despite the second wave of Covid-19 and a global shortage of semiconductors. Retail sales of vehicles increased by 7% in 2021-22 when compared with the previous year. The 2-wheeler segment, which was already a non-performer due to rural distress, saw further dampening due to rise in vehicle ownership cost coupled with rising fuel cost.

The passenger vehicle segment continues to see high demand and long waiting period as semi-conductor availability still remains a challenge even though supplies slightly improved from the previous month. The Russia-Ukraine war and China lockdown will further dent supplies and hence press brakes on vehicle availability thus making waiting period more frustrating for customers.

Going forward: In the passenger vehicle segment, demand isnt going to be a problem - there is a massive backlog with every company. With demand still buoyant in the passenger vehicle segment despite challenges of commodity price increases, many automobile manufacturers are upbeat to embrace new technologies, especially in the electric mobility space which is expected to witness a slew of launches in both four- and two-wheeler categories in the coming year.

Government support to the auto sector

1) The Production Linked Incentive (PLI) Scheme for the auto sector aims to make the industry future ready by incentivising the advance technology components. It is estimated that over a period of five years, the PLI Scheme for Automobile and Auto Components Industry will lead to fresh investments of over Rs.42,500 crore. 2) In December 2021, the government had approved Rs.76,000 crore incentive scheme for semiconductors under which India will set up more than 20 semiconductor design, components manufacturing and display fabrication units over six years.

Business operations

"We will continue to work along with our Japanese partner to further improve our processes to match their efficiency and quality."

Were you satisfied with the Companys performance in FY22?

It was the best year in the Companys history as we set new benchmarks on all accounts – production, sales, operational efficiencies and cost optimisation. We achieved this performance despite the second wave of the pandemic in the initial months of FY22 – this made our achievement more satisfying.

On shop floor efficiencies, what were some of the important initiatives?

Our steel output increased by 24% from 1,34,091 MT in FY21 to 1,65,809 MT in FY22. This improvement has transpired because of multiple small process improvements undertaken over the last couple of years which have now yielded improved results. We believe that there is further room for improvement across all parameters. We, along with our Japanese partner, continue to ideate solutions to enhance our process efficiencies.

What was the one major step you took to make your operations stronger?

Yes, there was one major initiative we implemented in FY22. That was a change in our raw material sourcing. Till the previous year, we used imported scrap as the key input in our steel manufacturing process. The pandemic and the consequent supply chain disruption across the globe forced us to think of a sustainable alternative. In FY22, we switched to domestic steel scrap. This was a big change as it required tweaking our steel-making processes to ensure that our steel quality was sustained despite this change. This step has made our operations cost-competitive and sustainable.

The team started the ‘Suggestion Box practice in the previous year. How did that help in overall process improvements?

When we launched this concept, it generated considerable excitement and energy among the team. We received about 2,000 suggestions. We bucketed them under four categories based on time and resources required and their criticality. While phase 1 was implemented in FY21, we worked on phase 2 which comprised about 700 suggestions in FY22. We will continue to work on the remaining ideas in the current year.

Did the Company incur any capital expenditure during the year under review?

We invested about Rs.35 crore in capital expenditure in our unit. The most important among them was the modifications made in the Continuous Casting Machine (CCM) which has increased its melting capacity from 2 lakh TPA to 2.60 lakh TPA. This will help us reduce the dependence on outsourced steel. It will also improve the quality of the final products delivered to the customer. The other important capital expense was related to switching over the fuel for our reheating furnace from Furnace oil to Natural Gas, a cleaner fuel that will go a long way in reducing our carbon footprint.

The Company was planning a capacity increase. Any further development on that front?

This was another milestone in FY22. We received approval from the Ministry of Environment for expanding our rolled-products capacity from 2 lakh TPA to 2.80 lakh TPA. The increase in our rolled-product output will go a long way in strengthening business relations with customers and in improving business profitability. The capex for the rolling mill will take place over the next three years.

What were some of the key highlights in the marketplace?

We achieved our highest sales volumes. We sold 1,73,308 lakh tonnes in FY22 against 1,50,265 lakh tonnes in FY21 – a jump of 15%. This growth was an outcome of the uptick in the automobile sector – primarily four-wheelers. The other important achievement was that we received sample approvals from some of the Japanese OEs operating in India. This reflects the improvement in our steel quality contoured by our Japanese partner. We hope to convert these sample approvals into trial lot approvals and mass production approvals over the medium term. When that happens, it will catapult Vardhman Special Steels into a new orbit altogether.

What is your plan for FY23?

We will focus on streamlining the processes and stabilise the production and quality of our steel from the SMS unit post the capacity expansion. We will work out the blueprint for expanding our rolled product capacity. On a more holistic basis, we will continue to work along with our Japanese partners to further improve our processes across our operating unit to match their efficiency and quality standards and we hope to increase our sales volume by 10-15%.

Financial performance

We registered an even better financial perfor- mance in termsof growth and profitability.

With every headwind, the Company only emerges stronger. This is the true character of Vardhman, which again shone bright in FY22, during which the Company posted an even better performance despite the second wave of the pandemic.

The Company reported Revenue from Operations of Rs.1,368.46 crore in FY22 against C937.08 crore in FY21. The healthy uptick was owing to an increase in sales volumes and improved realisation. EBITDA scaled by 74% from Rs.116.31 crore in FY21 to Rs.202.58 crore in FY22.

The EBIDTA margin improved from 12% in FY21 to 15% in FY22. The improvement in EBITDA encapsulates the improved realisation, increase in share of value-added products and cost optimisation initiatives implemented by the team and some help from the positive sentiments for steel industry.

Net Profit cross the elusive three-figure benchmark – it stood at Rs.100.75 crore in FY22 against Rs.44.19 crore in FY21. The feeling of the breakout was surreal. The holistic improvement in business performance and profitability helped in strengthening the Balance Sheet and improving the organisations liquidity.

Net Cash flow from Operations stood at Rs.58.88 crore in FY22 against Rs.67.28 crore in FY21. The Company prudently deployed this liquidity in paring its debt burden and in capability building.

Networth increased appreciably as business surplus (after paying dividend) was ploughed into the operations – it stood at Rs.554.96 crore as on March 31, 2022 against Rs.459.36 crore as on March 31, 2021. The Return on Networth also upped considerably – from 10% in FY21 to 20% in FY22.

The working capital requirement increased with the growing business operations. The working capital cycle stood at 82 days in FY22 against 63 days in FY21.

The net debt portfolio was Rs.121.53 crore as on March 31, 2022 against Rs.135.90 crore as on March 31, 2021. As a result, the interest liability reduced from Rs.19.71 crore in FY21 to Rs.17.28 crore in FY22. The net debt-equity ratio improved from 0.30x to 0.23x over the same period.

The strong financial position and improved prospects positions the Company perfectly for improving its performance in the current year.

Key Financial Ratios

Particulars	UOM	2021-22	2020-21	Change (%)	Reason for change of 25%
					or more
Trade Receivables Ratio	(x)	6.13	4.64	32.11	Due to decrease in the credit days, overall increase in business volumes and better collection efficiency.
Inventory Turnover Ratio	(x)	5.51	5.45	1.10
Interest Coverage Ratio	(x)	8.41	5.02	67.53	Higher Profitability & lower interest rates resulted in improvement in this ratio.
Current Ratio	(x)	2.27	2.09	8.61
Net Debt-Equity Ratio	(x)	0.23	0.30	-23.33
Operating Margin	%	12.69	11.03	15.05
Net Profit Margin	%	7.36	4.72	55.93	These ratios have increased on account of higher margins, higher volumes & electricity duty exemption accounted under Industrial Policy, 2017 for the period Sep19 to Mar22.
Return on Net Worth	%	19.87	10.12	96.34

Risk management

We work continually to mitigate our business risk that could have an adverse impact on our business performance.

The risk management process at Vardhman begins with the identification of risks and an assessment of their impact. The assessment is based on past trends and future projection. Thereafter, ways to mitigate these risks are identified and implemented when necessary. Risks, once identified, are periodically monitored, along with emerging risks.

Demand risk: A slowdown in the automotive sector could curtail demand for our products.

Mitigation measure: The Company enjoys strong business relations with leading OEMs in the automotive sector – especially in the passenger vehicle and 2-wheeler spaces. This wide customer base cushions the Company from a drop in volumes in any one segment.

Vardhman has commenced exports of its products to the multiple facilities of its global partner Aichi Steel – volumes are expected to be ramped up in a phased manner over the coming years. This could promise a continuous flow of business to the Company.

Quality risk: A drop in product quality could result in customer attrition.

Mitigation measure: At Vardhman quality is not a process, it is a habit that has, over the years, transformed into its culture. The passion for quality enables the Company to cater to all OEMs operating in India. Further, the global partner is helping the Company to move further up the quality barometer – to match international standards. The journey has only just begun.

Cost risk: Increase in cost of inputs and utilities could impact business margins.

Mitigation measure: This will impact every player in the sector without exception. Vardhman is better placed as it can pass on some part of the cost increase to its customers. Besides, the shopfloor team continues to endeavour to improve operational efficiencies and improve productivity to absorb part of the cost increase in material and utilities.

Safety risk: The Companys operations are high-risk in nature.

Mitigation measure: Vardhmans key assets are its people. Hence people safety is of paramount importance to the Leadership team. This was reflected in the pandemic and lockdowns. The Company left no stone unturned to ensure the safety of its team members. To safeguard its operations teams, the Company has created a Safety Cell which provides training (which includes mock drills) to its people to instill safety consciousness. Moreover, with Aichi Steel members being present on the Vardhman shopfloor, safety has climbed a few notches higher.

Funding risk: The Company may not be able to garner sufficient funds to implement its strategic initiatives and enjoys a AA rating from CRISIL.

Mitigation measure: Vardhman is comfortably placed with regard to its business liquidity. The Company has a healthy net debt-equity ratio at 0.23x as on March 31, 2022, which allows it to borrow low-cost funds from bankers and other financial institutions when required. Further, the company has strong parents and can infuse funds to support any expansion.

Human resources/ Industrial relations

Human resource is considered as the most valuable of all resources available to the Company. The Company continues to lay emphasis on building and sustaining an excellent organization climate based on human performance. The Management has been continuously endeavoring in fostering high performance culture in the organization. During the year, the Company has employed around 1,031 employees on rolls. Further, industrial relations remained peaceful and harmonious during the year.

Internal control systems and their adequacy:

Your Company has been regularly reviewing and updating its internal controls by benchmarking against the industry standards. Dynamics of changing business requirements, statutory compliances and corporate governance are adopted in existing systems after careful review to remain in line with compliance requirements, expectations of business partners like customers and institutions. Senior management monitors the recommendations of internal audits for continuous system updating. IT System infrastructure is updated regularly to support business decision making as well as better controls.