India Ratings Assigns HEG’s CP ‘IND A1+
Delhi-20 May 2015: India Ratings and Research (Ind-Ra) has assigned
HEG Limited’s (HEG) INR1,000m commercial paper an ‘IND
A1+' rating. A full list of ratings is at the end of this commentary.
The CP will be used to fund the working capital requirements. Of the overall working capital facility, a portion will be kept unutilised to the extent of CP issuance.
KEY RATING DRIVERS
Bottoming Out of Credit Risk: The ratings are underpinned by an improvement in HEG’s credit metrics over FY14-FY15 despite a weak operating environment and revenue slowdown. The ratings also reflect the company’s ability to manage cash flow and resilience in profitability due to favourable raw material pricing and terms, coupled with the low cost of captive power generation.
Improved Profitability, Softer Revenue: EBITDA margins improved to 16.9% in 9MFY15 from 15.1% in FY14 (FY13: 14.7%, FY12: 10.5%), led by lower forex losses as well as lower power and fuel costs, along with reduced crude prices. Revenue declined 9.6% yoy in FY14 and around 13% (provisional) in FY15, led by lower volumes and realisations in the graphite electrodes (GE) business due to overcapacity and a slowdown in the steel sector, which drives GE demand. The capacity utilisation decreased to 70% in FY14 and remained at the same level in 9MFY15 (FY13: 78%).
Ind-Ra expects HEG to sustain revenue in FY16 at FY15 levels as price cuts in GE have been contained, even as order book visibility is lower (30% of capacity) and steel demand outlook remains subdued.
Fixed Raw Material Prices: HEG contracts majority of its raw material (needle coke, a crude oil derivative) for 12 months and hence could not benefit from the lower raw material prices October 2014 onwards. However, it sources some raw materials on a spot basis, which partly compensates the impact of fixed-price contracts. HEG has been able to contract needle coke for 2015 at a favourable pricing which is likely to support the margins.
Comfortable Liquidity: Significant working capital improvements led to positive cash flow from operations (CFO; FY14: INR7bn; FY13: INR538m) and free cash flow (FCF; FY14: INR4bn, FY13: negative INR1.36bn) in FY14. These were driven by a reduction in inventory days to 185 in FY14 from 199 in FY13, a reduction in receivables days to 130 from 135 and an improvement in payables days to 67 from 35. However, the net cash conversion cycle remained long at 248 days in FY14 (FY13: 298 days), due to the long production cycle for both electrodes and connectors, which is an industry-wide phenomenon and reflects working capital intensive nature of business. Also, HEG’s average use of the fund-based limits was 70% utilisation during the 12 months ended March 2015 and its interest coverage was comfortable at 3.1x in 9MFY15.
Over the last two years, HEG’s raw material accessibility has improved with low end-use capacity utilisation leading to an oversupply situation and eventually a buyers’ market. Hence, the payables period also improved as payment terms eased. HEG reported positive FCF in FY14 of INR4.05bn, led by high CFO generation.
Barriers to Entry: The ratings are underpinned by HEG's position as one of India’s leading GE manufacturers, its diversified customer base and its 100% self-sufficiency in power. The entry barriers, in terms of capital and technology, remain high which gives an edge to existing GE manufacturers. The government of India’s recent notification (February 2015) of anti-dumping duty of up to USD922.03/t on the import of Chinese electrodes into India is likely to provide a level-playing field to domestic players.
High Financial Leverage: Financial leverage (total adjusted net debt/EBITDA), though improved to 4.6x in FY14 (FY13: 5.83x; FY12: 8.43x), remains high for the rating level. The leverage improvement was driven by a reduction in both long-term and short-term debt in FY14. The leverage was 4.5x (annualised) at end-December 2014. Ind-Ra expects HEG’s leverage to reduce due to the measures taken to improve the working capital cycle and on the repayment of long-term debt.
Forex Risk: HEG remains exposed to fluctuations in foreign currency, given its exposure to exports, imports and foreign currency debt. HEG incurred a forex loss of INR200m in 9MFY15 (9MFY14: INR268.4m). However, the company has a partial natural hedge due to both imports and exports.
Positive: A significant improvement in the profitability resulting in the financial leverage being sustained below 3x will be positive for the ratings.
Negative: Negative rating factors include any large debt-funded capex plan, increased working capital intensity, a significant fall in the profitability or substantial support to group companies, which could lead to the financial leverage being sustaining above 4.5x.
HEG, set up in 1977, is a flagship company of the LNJ Bhilwara Group and is Asia's leading GE manufacturer and exporter with a manufacturing capacity of 80,000tpy at Mandideep, Madhya Pradesh. HEG reported revenue of INR14,668bn, EBITDA of INR2,213bn and net income of INR868m in FY14.
HEG’s ratings (including the above) are:
- Long-Term Issuer Rating: ‘IND A+’, Outlook Stable
- INR8,250m fund-based working capital facilities: Long-Term ‘IND A+’/Stable and Short-Term ‘IND A1+’
- INR3,100m non-fund-based working facilities: Long-Term ‘IND A+’/Stable and Short-Term ‘IND A1+’
- INR1,896.5m long-term loans: Long-Term ‘IND A+’/Stable
- INR1,000m commercial paper programme: Short-Term ‘IND A1+’
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