Detailed Rationale

CRISIL Ratings has reaffirmed its ‘CRISIL AA/Stable/CRISIL A1+’ ratings on the bank facilities and commercial paper programme of Kirloskar Oil Engines Limited (KOEL).

 

The ratings continue to reflect the company’s strong financial risk profile, established market position in the small and medium-sized diesel engine segment across key end-user industries and wide product portfolio with the electric pump business of LGMPL. These strengths are partially offset by susceptibility to cyclicality in end-user segments, volatility in raw material prices and intense competition in the diesel engine market.

 

Consolidated operating income grew by 25% to Rs 3,382 crore during the first nine months of this fiscal with Earnings before interest, tax, depreciation and amortisation (EBITDA) margin improving to 10.7% as compared to 7.1% during fiscal 2022. Operating performance improvement was broad based with growth across segments and end-user industries, increased exports and lagged- impact of price increases taken since last fiscal as well as moderating raw material prices this fiscal. Margins were impacted in fiscal 2022 owing to substantial increase in raw material prices which the company was only able to pass-on partially to customers primarily in price conscious small pumps business of its subsidiary, La Gajjar Machineries Pvt Ltd (LGMPL; ‘CRISIL A+/Stable/CRISIL A1’).

 

The company has undertaken strategic initiatives to drive its growth over the medium term while maintaining its double-digit margin profile. CRISIL Ratings expects revenue growth to be healthy at 25-30% during this fiscal while EBITDA margin is expected to remain at double-digits despite high raw material prices. Sustenance of healthy revenue growth while maintaining double-digit EBITDA margins over the medium term, remains a key monitorable. Furthermore, the financial risk profile remains robust, supported by strong capital structure with low debt, strong debt protection metrics and healthy liquidity.

 

The ratings factor in equity infusion of Rs 934 crore (excluding profits-reinvested) as of September 2022 in ARKA (ARKA Fincap Ltd and ARKA Financial Holdings Pvt Ltd, together called ARKA), which is KOEL’s wholly owned subsidiary in the non-banking financial company (NBFC) segment. KOEL has also purchased the remaining 24% stake in LGMPL for about Rs 109 crore in September-2022 from the erstwhile promoters. These investments were funded through cash and liquid investments, which led to their moderation to Rs 302 crore level as on September 30, 2022 as compared to Rs 638 crore in March-2021. The financial risk profile will remain strong even after capital infusion in ARKA, taking total investments to Rs 1,000 crore by fiscal 2023, backed by strong debt protection metrics and negligible term debt obligation. Developments in the NBFC subsidiary and higher-than-expected investment from KOEL will be key monitorables.

Analytical Approach

For arriving at the ratings, CRISIL Ratings has combined the business and financial risk profiles of KOEL and its subsidiaries, Kirloskar Americas Corp (100% subsidiary) and LGMPL (100% subsidiary effective September-2022), collectively referred to herein as KOEL, as the entities have common management and operational linkages. For the financial subsidiary, ARKA, CRISIL Ratings has used the capital allocation method. Cash outflow towards investment of Rs 934 crore in ARKA by September 2022 has been considered.

 

Please refer Annexure - List of entities consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths:

Strong financial risk profile

Networth was healthy at Rs 1,860 crore, and gearing was low at 0.12 time, as on March 31, 2022. Interest coverage ratio stood at about 23 times in fiscal 2022 and will remain healthy over the medium term. Consolidated debt stood at Rs 234 crore with liquid surplus of Rs 302 crore as of September 30, 2022. The financial risk profile is likely to be sustained over the medium term, despite annual capital expenditure (capex) of about Rs 300 crore (including stake purchase in LGMPL) and additional investments in ARKA, on account of steady cash accrual. Larger-than-expected capex or acquisition, having material impact on the liquidity or capital structure, will be a key monitorable.

 

Established market position in the small and medium-range diesel engine segments

The company has strong presence in diverse sectors, such as power generation, agriculture and industrial. Its market position is well established, particularly in the agriculture and industrial sectors; a bulk of the revenue comes from diesel-powered farm pump sets (agriculture) and engines for construction equipment (industrial). Acquisition of controlling stake in LGMPL has provided KOEL a significant footprint in the electric pump market. While the operating performance has been marginally impacted owing to subdued demand in the industrial and power generation segments, LGMPL’s business has provided stability. As part of its strategic growth initiatives, KOEL has invested heavily in technology, channel partners, people as well as operations and manufacturing to not only capture the domestic demand which is witnessing changing emission norms but also drive strong growth in export markets given product and distribution channel readiness. These will support healthy revenue growth while maintaining double-digit EBITDA margins for the company over the medium term and remains a key monitorable.

 

Weaknesses:

Susceptibility to cyclicality in end-user industries

Because of the nature of products, the company’s prospects remain linked to capex undertaken by end-user industries. Susceptibility to cyclicality in demand should persist, reducing revenue contribution from the impacted segment, as witnessed in the industrial and power generation segments in the past few fiscals.

 

Exposure to volatility in raw material prices and intense competition

Raw material cost accounts for 66-67% of operating income. Profitability, therefore, is susceptible to volatility in the prices of raw materials, particularly on account of the intensely competitive small- and medium-range diesel engine segment. The company faces competition from unorganised players in the small diesel engine segment, and from entities such as Cummins India Ltd, Ashok Leyland Ltd and Mahindra & Mahindra Ltd in the medium diesel engine segment.

Liquidity: Strong

Liquidity will remain strong over the next two fiscals supported by healthy cash accrual. Term debt obligation is expected to be minimal at Rs 8-11 crore annually over the next two fiscal; and moderate capex plans 120-150 crore (mainly at LGMPL) which will be funded through internal cash accrual. KOEL had liquid surplus of Rs 302 crore as on September 30, 2022. Utilisation of the fund-based limit of Rs 313 crore was nominal. Liquidity should remain adequate, despite capex and additional investment in ARKA. Any larger than expected capex or acquisition could adversely impact KOEL’s liquidity position and will remain the key monitorable.

Outlook: Stable

KOEL will continue to benefit from its established market position and large product portfolio catering to diverse sectors. The financial risk profile will remain strong, supported by robust capital structure and debt protection metrics.

Rating Sensitivity Factors

Upward Factors 

• Substantial and sustained increase in revenue and profitability, driven by product launches or higher sales to major end-user segments, resulting in annual net cash accrual over Rs 400 crore
• Efficient working capital management and maintenance of the healthy financial risk profile
• Sustained strong liquidity profile

 

Downward Factors

• Weaker business performance owing to downturns in end-user industries, constraining revenue and profitability, resulting in annual net cash accrual below Rs 150 crore
• Large, debt-funded capex or acquisition, leading to substantial reduction in liquid surplus levels
• Stretched working capital cycle or debt funded acquisition resulting in substantial increase in gearing

About the Company

KOEL, one of the flagship companies of the Kirloskar group, manufactures and services diesel engines (primarily between 2.5-740 horsepower) and diesel generator sets (mainly between 2-1,010 kilovolt ampere). The company also makes diesel, petrol and kerosene pump sets. It has manufacturing units in Pune, Kagal, Rajkot and Nashik. It caters to the agriculture, power generation and industrial sectors.

 

For the first nine of fiscal 2022, on a consolidated basis (including ARKA), net profit was Rs 253 crore on operating income of Rs 3,640 crore, against Rs 103 crore and Rs 2,840 crore, respectively, in the corresponding period of the previous fiscal.

Key Financial Indicators*

Particulars	Unit	2022	2021
Operating income	Rs crore	3817	3189
PAT	Rs crore	204	190
PAT margin	%	5.4	6.0
Adjusted debt/adjusted networth	Times	0.12	0.10
OPBDIT interest coverage	Times	22.8	26.7

*CRISIL Ratings-adjusted consolidated numbers

Any other information: Not applicable