Detailed Rationale

CRISIL Ratings has upgraded its rating on the long-term bank facilities of Happy Forgings Ltd (HFL) to 'CRISIL AA/Stable' from 'CRISIL AA-/Stable'.

 

The rating action reflects the strong improvement in the financial risk profile of the company following equity infusion from its initial public offering (IPO) in December 2023. The company raised funds of around Rs 380 crore post accounting for IPO expenses (primary issuance). From the proceeds, it has prepaid debt of Rs 153 crore, which lowered debt levels to Rs 120 crore as on January 31, 2024, from Rs 219 crore as on March 31, 2023, and will use Rs 171 crore to fund capital expenditure (capex) over the medium term and the remaining for general corporate purpose. As a result, net worth is expected to increase to around Rs 1,600 crore in fiscal 2024 from Rs 984 crore in fiscal 2023. Total outside liabilities to tangible networth (TOLTNW) ratio is expected to improve to 0.14 time as on March 31, 2024, from 0.34 time as on March 31, 2023. The rating action also reflects improvement in the business risk profile supported by increasing diversification into non-auto (non-automotive) segments and product and customer base, and established position in the domestic forged and machined components market, especially in the commercial vehicles (CV) segment.

 

Revenue is expected to increase over Rs 1,400 crore in fiscal 2024 supported by healthy segment and client diversity across the CV and tractor segments, and diversified product offerings, mitigating the impact of demand slowdown in a segment. Revenue grew at compound annual rate of 16% during the past five fiscals to around Rs 1,197 crore in fiscal 2023. Diversified product portfolio, and healthy segmental and customer diversity mitigates the risk of slowdown in a segment. Operating margin will remain healthy around 29% over the medium term, supported by ability to pass on increase to original equipment manufacturers (OEMs) as well as reduction in power expense on account of setting up of solar rooftop plant and increasing proportion of higher-margin machined products. The operating margin is expected to sustain at 27-29% supported by a change in product mix to heavier products which offer better margins. The financial risk profile will remain healthy, supported by strong cash accrual over Rs 300 crore and nil term debt obligation. Debt metrics will remain comfortable with interest coverage expected at above 30 times and gearing expected to improve to 0.05-0.06 time over the medium term.

 

The rating factors continued increase in scale of operations, with strong clientele in the auto and industrial segments across geographies, established relationships with OEMs and sound technical capabilities. Furthermore, the financial risk profile has also improved with interest coverage ratio at 29 times in fiscal 2023, compared with 22 times in fiscal 2022. Net cash accrual also improved, strengthening the cushion between net cash accrual and debt obligation, supporting the liquidity.

 

These strengths are partially offset by large working capital requirement and susceptibility to downturns in the CV or tractor segments.

Analytical Approach

CRISIL Ratings has considered the standalone business, financial and management risk profiles of HFL.

Key Rating Drivers & Detailed Description

Strengths:

• Healthy business risk profile supported by strong relationships with customers: The company has a track record of more than three decades in the forged and machining components business and is the main supplier to several leading domestic OEMs. It has added customers and products to diversify its business risk profile. Strong demand for CVs and tractors has supported growth in revenue over the past few quarters. The company will benefit from strong linkages with customers as well as addition of new customers and increased machining products proportion, which will support profitability over the medium term.

 

• Increasing segment and customer diversity: Sales to cyclical sectors such as tractors and CVs contributed to 41% and 34% of revenue, respectively, in fiscal 2023. The balance 25% comes from off-highway vehicles, industrials and scrap sales. In the nine months of fiscal 2024, in line with the company’s plans of diversification, the industrial segment contributed to 13%, as against 3% in fiscal 2023, on account of commissioning of presses, such as 14000T press in fiscal 2023, which manufactures components of 90-250 kg. Dependence on a segment will reduce, shielding the company from downturns. It has good customer diversity and supplies to leading players in both the tractor and CV segments; it supplies to more than 60 customers with its largest customer accounting for 12% of revenue in the nine months of fiscal 2024 and the top five around 47%. Exports have increased to 20% in the nine months of fiscal 2024 from 12% in fiscal 2023 and 11% in fiscal 2022.

 

The company benefits from being one of the largest manufacturers of crankshafts and axle beams, which is supported by superior growth vis-à-vis industry. It is in the process of adding a new line in the forging segment with installation of 6,300 MT and 10,000 MT press lines, which will complete the entire value chain in the forging lines from 2,500 MT to 14,000 MT.

 

• Strong financial risk profile: The financial risk profile improved substantially owing to proceeds of around Rs 380 crore from its IPO in fiscal 2024 despite capex of around Rs 200 crore per annum over the medium term. From the proceeds, the company has prepaid debt of Rs 153 crore. Despite the capex, gearing is expected to improve to 0.05-0.06 time in fiscal 2024 from 0.2 time as on March 31, 2023, as the company has reserved around Rs 171 crore from the IPO proceeds for capex and yearly net cash accrual is expected around Rs 300 crore. The financial risk profile will remain healthy, with interest coverage ratio above 30 times over the medium term.

 

Weaknesses:

• Large working capital requirement: Operations are working capital intensive, as reflected in gross current assets (GCAs) of 149 days as on March 31, 2023, owing to sizeable inventory, given the large product range and high lead time for manufacturing. Also, increasing proportion of export may keep receivables stretched. Receivables stood at 109-94 days in the past five fiscals. Prudent management of the working capital cycle remains a rating sensitivity factor.

 

• Susceptibility to cyclicality in the CV and tractor segments: The CV segment is vulnerable to growth in industrial and agricultural production, freight movement, share of road transport in freight movement, changes in freight rates and fuel prices, profitability of truck operators, state transport undertakings and government policies. Also, tractor demand is vulnerable to the vagaries of monsoon and farm income. Capex coinciding with weak demand may pose risk of slower ramp-up of capacities and will remain a key monitorable.

 

While HFL has been diversifying its customer base, revenue and profitability remain susceptible to segmental concentration as the company derives around 34% from the CV segment and 41% from the tractor segment. This fiscal, CV demand will remain strong while tractor demand will moderate owing to erratic monsoon.

Liquidity: Strong

Cash accrual is expected above Rs 300 crore in fiscal 2024 against nil term debt obligation. Utilisation of fund-based limit was moderate at 66% on average during the 12 months through December 2023. Steady accrual and unutilised bank lines will sufficiently cover working capital requirement.

Outlook: Stable

HFL will continue to benefit over the medium term from the initiatives it has taken to increase business from existing domestic and overseas customers and to enhance opportunities in both markets. Furthermore, improving cash accrual should help sustain the healthy financial risk profile over the medium term despite the capex.

Rating Sensitivity factors

Upward factors:

• Growth in revenue, driven by sustained diversification in product and customer base, and increase in share of industrials and other new end user industries to above 30% 
• Significant growth in revenue and Sustenance of operating margin above 28%  

 

Downward factors:

• Decline in cash accrual leading to higher dependence on external debt and TOLTNW ratio above 1.5 times
• Major debt-funded capex or acquisitions, or material reduction of liquid surplus owing to large dividend payout weakening the debt metrics

About the Company

Established in 1979 by Mr Paritosh Kumar Garg (Chairman cum  Managing Director) and his father, Mr Channan Ram Garg & and further well supported by Mr. Ashish Garg, Managing Director (son of Mr. Paritsoh Kumar Garg), HFL manufactures forged and machined components, primarily crankshafts, for the automotive and non-automotive segments. Facility in Ludhiana has forging capacity of 1,20,000 TPA and machining capacity of 51,000 TPA.

Any other information: Not Applicable