Detailed Rationale

CRISIL Ratings has upgraded its rating on the long-term bank facilities of Kirloskar Oil Engines Ltd (KOEL) to 'CRISIL AA+/Stable’ from ‘CRISIL AA/Positive’. The rating on the short-term bank facilities and commercial paper programme has been reaffirmed at ‘CRISIL A1+’.

 

The upgrade follows continuing and healthy improvement in the business risk profile of KOEL, as well as maintenance of strong financial risk profile. The improvement in business profile is driven by better diversified portfolio, with the larger Business-to-Business (B2B) segment anchored by continuing strong market share in the small and medium-range diesel gensets, product readiness with in-house developed multi-fuel and CPCB IV+ gensets driving the improvement in product mix, as well as steady rise in penetration in the higher-margin high horse-power (HHP) categories. Besides, rising share of customer service sales and exports, and established market position in the agriculture and pumps systems are also expected to support revenues over the medium term.

 

Besides, KOEL’s operating profitability is also expected to sustain at ~11% over the medium term, leading to strong annual cash generation. This will also enable KOEL to meet its capex requirements leading to minimal reliance on debt, and continuation of strong financial risk profile. Debt protection metrics are expected to continue at healthy levels.

 

KOEL’s operating income grew at a compound annual growth rate of 19% between fiscals 2022-2024, and by ~17% on-year to Rs. 5431 crore in fiscal 2024, while its operating profitability or earnings before interest, tax, depreciation and amortisation (Ebitda) margin too improved to 11.1% in fiscal 2024, from 9.6% in fiscal 2023, with strong focus on its ‘2X3Y’ (double revenues in three years from fiscal 2022 at double digit margins) growth strategy. The operating performance was driven by robust ~20% growth in the higher-margin B2B segments while B2C segment growth was modest at ~5%. The improvement in the operating performance was broad based across segments with pre-buys of sunset CPCB II engines driving growth in the first half of fiscal 2024, followed by increasing sales of HHP engines, well-supported by large engines, customer support segments and exports. The company has increased share of higher-margin exports and customer service revenue with growth of ~16% and ~18% y-o-y, respectively in fiscal 2024. Exports and customer service each contribute 14-15% to consolidated revenues in fiscal 2024 from ~12% each in fiscal 2022. KOEL’s pump subsidiary, La-Gajjar Machineries Private Limited (LGMPL, rated ‘CRISIL AA-/Stable/CRISIL A1+’) recorded a moderate decline in revenue of ~4% in fiscal 2024; albeit, operating margins almost doubled to 8.6% last year from 4.1% in fiscal 2023.

 

As of March 2024, KOEL has infused Rs 1,053 crore (including Rs 53 crore of reinvested profits) in ARKA (ARKA Financial Holdings Pvt Ltd, ARKA Fincap Ltd and ARKA Investment Advisory Services Pvt Ltd, together referred to as ARKA), its wholly owned subsidiary in the non-banking financial company (NBFC) segment. Strong cash accruals with moderate capex spend in fiscal 2024 has boosted cash and liquid investments, which grew to Rs 495 crore as on March 31, 2024, from Rs 297 crore as of March 2023. Material additional support to ARKA is not envisaged, but will remain a monitorable.

 

The ratings continue to reflect KOEL’s established market position in the small and medium diesel engine segment, enhanced product portfolio, improving operating capabilities and strong financial risk profile. 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.

Analytical Approach

For arriving at the ratings, CRISIL Ratings has combined the business and financial risk profiles of KOEL and its ‘manufacturing’ subsidiaries, including Kirloskar Americas Corporation (100% subsidiary) and its 51% subsidiary, Engines LPG LLC dba WildCat Power Gen (ELPG), as well as and LGMPL, 100% subsidiary effective September-2022, which also includes 100% step-down subsidiary Optiqua Electricals Private Limited which was amalgamated with LGMPL w.e.f. March 26, 2024 ), collectively referred to herein as KOEL, as the entities have common management and operational linkages. For Optiqua’s 49% (upto March 25, 2024 and LGMPL w.e.f. March 26, 2024) joint-venture entity, ESVA Pumps India Pvt Ltd, proportionate profits/losses are included.

 

CRISIL Ratings amortised Rs 184.5 crore of goodwill recognised in August 2017 for the LGMPL acquisition over five years ending August 2022.

 

For ARKA, CRISIL Ratings has used the capital allocation method for capital invested.

 

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:

• Established market position in the small and medium-range diesel engine segments; enhanced product profile and improving operating capabilities.: The company has a strong presence in diverse sectors, such as power generation, agriculture and industrial. Its market position is well established, particularly in the small and medium horse-power genset segment, where it holds around 30% market share in India and is growing its penetration in the HHP segment with launch of new products. It also supplies engines to construction and industrial sectors, for machines supporting farming and agriculture activities, and electric and diesel power water management solutions. Acquisition of 100% stake in LGMPL has provided KOEL a significant footprint in the electric agri-pump market.

 

KOEL has an established research and development (R&D) team, which has developed and launched new products in HHP categories, products complying with new emission norms, multi-fuel types etc. With significant pre-buys of legacy CPCB II engines seen in first half of fiscal 2024 and CPCB IV+ (applicable on engines up to 800 kilovolt ampere [kVA]) becoming mandatory wef July 01, 2024, volumes may remain rangebound in fiscal 2025. However, the new generation engines being priced 20-40% higher than legacy ones albeit generating similar margins, revenue growth is expected to be steady over the medium term. The new-engines have similar regulatory norms in developed countries including USA and Europe, and should lead to improved exports. The company has also appointed a GOEM in the Middle East and acquired 51% stake in US based ELPG, doing business under ‘Wildcat Power Gen’. ELPG is engaged in the business of designing, manufacturing, selling and servicing generators powered by gas, diesel and other environmental, fuel and power solutions. This acquisition is a step towards business expansion and to enable market development in the North American markets.

 

As part of its strategic growth initiatives, KOEL has invested heavily in technology, channel partners, people as well as operations to not only capture the domestic demand but also drive growth abroad, given its product and distribution channel readiness. Revenues from customer sales service has also witnessed a steady growth, with engines being monitored online by KOEL, ensuring prompt service. These initiatives will continue to support the company’s 2X3Y strategy plan.

 

Healthy revenue growth, rising share of exports and customer sale services offering better margins, and improved operating leverage has enabled KOEL to increase in operating profitability to 11.1% in fiscal 2024, from 9.6% in fiscal 2023 (~8% in fiscal 2022). While the Red-sea conflict has impacted freight rates for shipping to US and other markets, KOEL is still expected to sustain its operating profitability at ~11%, with rising share of higher HHP engines, and exports.

 

• Strong financial risk profile: While registering strong business growth, KOEL has also enhanced its profitability which has led to strong annual cash generation and supported its financial risk profile. Adjusted gearing remained low at 0.26 time as on March 31, 2024, albeit growing moderately from 0.12 time a year earlier, with gross debt increasing to Rs 305 crore from Rs 115 crore, last year. Interest coverage ratio remained robust at around 40 times in fiscal 2024 and will remain strong over the medium term.

 

KOEL is likely to undertake capex of ~Rs 400 crore in fiscal 2025 for capacity and capability enhancements as well as additional capex for plant consolidation at LGMPL. Accruals will suffice to meet capex needs obviating the need for material debt addition. Larger-than-expected capex or acquisition, or significant investments in ARKA, affecting the liquidity or debt protection metrics of KOEL, will be a monitorable.

 

Weaknesses:

• Susceptibility to cyclicality in end-user industries: The prospects of KOEL remain linked to capex by end-user industries. Susceptibility to cyclicality in demand will 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. Operating profitability, therefore, is susceptible to volatility in the prices of raw materials, particularly in the intensely competitive small- and medium-range diesel engine segment. KOEL faces competition from unorganised players in the small diesel engine segment, and from established and organised entities such as Cummins India Ltd, Ashok Leyland Ltd and Mahindra & Mahindra Ltd (‘CRISIL AAA/Stable/CRISIL A1+’) in the medium and large diesel engine segments.

Liquidity: Strong

Liquidity will remain strong over the next two fiscals supported by healthy cash accrual. Term debt obligation is expected to be low at Rs 60-80 crore annually over the next two fiscal. Capex of Rs 400 crore in fiscal 2025 and similar amounts in fiscal 2026 will be funded largely through accruals. KOEL had liquid surplus of Rs 495 crore as on March 31, 2024. Utilisation of the fund-based limit of Rs 313 crore was low. The company has already completed the committed Rs 1,000 crore investment in ARKA. Larger-than-expected capex or acquisition, or material investment in ARKA could constrain build-up in liquid surplus.

Outlook: Stable

KOEL is expected to continue consolidating its strong market position in domestic and export markets, driven by pick up in sales of CPCB IV+, HHP and spares, and sustain double digit operating profitability. The company is also expected to sustain its strong balance sheet and liquidity given steady cash generating ability and prudently funded capex.

Rating Sensitivity factors

Upward factors: 

• Sustained double digit revenue growth, supported by increasing share of HHP engines in domestic and export markets, and operating profitability of over 12-13% over medium-to-long term, ensuring strong cash generation
• Efficient working capital management and maintenance of the healthy financial risk profile and debt metrics.
• Sustained strong liquidity profile

 

Downward factors:

• Weaker business performance owing to downturns in end-user industries, constraining revenue growth and leading to lower operating profitability sustaining below 8%
• Large, debt-funded capex or acquisition, or elongation in working capital cycle, leading to higher debt levels, impacting key debt metrics
• Material reduction in liquid surpluses due to high dividend payout, share buy-back or capital reduction, or additional investment in ARKA.

Key Financial Indicators*

Particulars	Unit	2024	2023
Operating income	Rs.Crore	5431	4649
PAT	Rs.Crore	382	263
PAT margin	%	7.0	5.7
Adjusted debt/adjusted networth	Times	0.26	0.12
OPBDIT interest coverage	Times	40.5	29.2

*CRISIL Ratings-adjusted consolidated numbers

Any other information: Not Applicable