Key Rating Drivers & Detailed Description

Strengths:

Healthy business risk profile supported by strong relationships with customers

The company has been in the automotive forgings segment for over three decades, and manufactures 50-60 types of forged components in 10-15 sizes and variants per product. Furthermore, strong relationship with customers such as Ashok Leyland Ltd (ALL), Bharat Gears Ltd, Graziano Transmission India Pvt Ltd, JCB India Ltd. and VE Commercial Vehicles is reflected in repeat orders. With increase in capacity revenue growth is also expected to increase due to increasing share of business with existing clients and addition of new clients. Also, HFL is a preferred supplier for ALL and started with supplies of suspension for trucks and gradually penetrated into suspension and crankshafts requirement, thereby increasing penetration per vehicle and share of business. Over the medium term, and with utilisation levels being upped at new presses, HFL is expected to benefit from strong linkages with existing customers as well as addition of new customers, including Tata Motors Ltd. Machining proportion over the years has been increasing which supported operating margin to improve to over 25% on sustained basis

Healthy segmental and customer diversity with improving product range

Sales to cyclical sectors like tractors and CV vehicles contributed 45% and 30% of the revenue respectively in fiscal 2022. The balance 25% is derived from passenger cars and utility vehicles, off-highway vehicles, railways and scrap sales. HFL also has good customer diversity and supplies to leading players in both the tractor and CV segments; it supplies to more than 40 customers with its largest customer accounted for only 14% of revenues in fiscal 2022 and top 5 contributing to around 46%. Exports also increased to 11% in fiscal 2022. With commissioning of newer presses, HFL will further diversify its portfolio to include newer customers as well as increase its share in segments other than MHCV and tractors. HFL has also started diversifying by moving into the non-automobile space like wind, oil& gas etc.

Strong financial risk profile

Financial risk profile has improved over the years on the back of healthy cash accrual, progressive debt repayment and equity infusion in fiscal 2019. Motilal Oswal Private Equity (MOPE) invested Rs 200 crore in HFL in fiscal 2019, which helped HFL repay debt as well as fund capex. Gearing is estimated to improve to 0.16-0.20 time in fiscal 2023, from 0.3 times as of March, 2022. In fiscal 2023, company is expected to undertake capex of Rs. 175 crore. Annual capex is estimated at Rs.35-40 crore from fiscal 2024 onwards. The capex in fiscal 2022, is expected to be part funded by debt of Rs. 100 crore. Despite the addition of debt, the financial risk profile is expected to remain healthy, as cash generation will continue to remain strong. The gearing is expected be below 0.3-0.4 time and debt to Ebitda ratio is expected at 0.8-1 time over the medium term.

MOPE’s fund, India Business Excellence Fund–III, has 11.76% stake in HFL. The exit  to MOPE can be through other routes including sale to another private equity player or through an initial public offering Any material change in this understanding or debt raise by HFL  will be key monitorables.

Weakness:

Large working capital requirement: Operations are working capital intensive, as reflected in gross current assets (GCAs) of 191 days as on March 31, 2022 The high GCA days are mainly due to sizeable inventory, given the large product range and high lead time required for manufacturing. Operations will remain working capital intensive due to increasing exports which are more working capital intensive. Also, increasing proportion of exports may keep debtors at elevated level. Debtor days have varied between 118 days to 94 days in the past five fiscals. Prudent management of the same 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.

Hence, high dependence on these segments poses a risk to revenue and profitability. While HFL has been gradually diversifying its customer base by addition of new clients, revenues and profitability will remain susceptible to segmental concentration, given that HFL derives around 45% from CV segment and 30% tractor segment. This fiscal, CV demand is expected to remain on a recovery mode recover after consecutive weak years, while tractor demand is expected to remain moderate.

Key Financial Indicators

Annexure - Details of Instrument(s)

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