Detailed Rationale

CRISIL Ratings has revised its rating outlook on the long-term bank facilities of Kirloskar Oil Engines Limited (KOEL) to ‘Positive’ from 'Stable' and reaffirmed the ‘CRISIL AA’ rating, and has reaffirmed its ‘CRISIL A1+’ rating on the company’s short-term bank facilities and commercial paper programme.

 

The outlook revision reflects the expectation of continued improvement in the operating performance of KOEL over the medium term, with sustained strong financial risk profile. This will be driven by product mix with increased sales in the high horse-power (HHP) categories and multi-fuel engine segments, and geographical diversification in revenue with higher share of exports. KOEL’s leading market position in the small and medium-range diesel engine segments, product readiness with new CPCB 4+ emission compliant gensets (priced 20-30% higher than legacy engines), along with the sale of sunset CPCB 2 genset and pumps systems, should lead to strong double-digit revenue growth over the medium term. Resultantly, earnings before interest, tax, depreciation and amortisation (Ebitda) margin over the medium term should also sustain in double-digits. Low debt, robust debt protection metrics and healthy liquidity will keep the financial risk profile strong.

 

Consolidated operating income grew 22% to Rs 4,649 crore in fiscal 2023, while Ebitda margin improved to 9.6% from 7.1% in fiscal 2022. The operating performance remained healthy in the first quarter of fiscal 2024 with operating income growing 27% on-year to Rs 1,415 crore and Ebitda margin improving to 11.9% with Ebitda of Rs 168 crore, supported by pre-buy of sunset CPCB 2 engines. The improvement in the operating performance was broad based across segments and end-user industries, with increased exports and lagged impact of price increases since last fiscal as well as moderating raw material prices this fiscal. Margins were impacted in fiscal 2022 by substantial increase in raw material prices which the company was able to pass on only partially, primarily in the price-conscious small pumps business of its subsidiary, La Gajjar Machineries Pvt Ltd (LGMPL; ‘CRISIL A+/Positive/CRISIL A1’).

 

KOEL has adopted the ‘2X3Y’ strategic plan, implemented since August 2022, to double its standalone revenue from the fiscal 2022 level while maintaining double-digit Ebitda margin over the next three years. This will be driven by improved market penetration in HHP categories and overseas markets, and strong market position in the small and medium genset, agriculture and pumps segments. Sustenance of strong revenue growth while maintaining double-digit Ebitda margin remains monitorable.

 

As of June 2023, KOEL had infused Rs 1,053 crore (including profits reinvested) in ARKA (ARKA Fincap Ltd and ARKA Financial Holdings Pvt Ltd, together referred to as ARKA), its wholly owned subsidiary in the non-banking financial company (NBFC) segment. KOEL purchased the remaining 24% stake in LGMPL from the erstwhile promoters for around Rs 107 crore in September 2022. These investments were funded through cash and liquid investments, which moderated to Rs 297 crore as on March 31, 2023, from Rs 638 crore as of March 2021. KOEL is likely to undertake capital expenditure (capex) of Rs 250-350 crore annually over the next two years for new office purchase, investments for capacity and capability enhancements as well as plant consolidation for LGMPL. The financial risk profile will remain strong despite the capex, backed by strong cash generation. 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

CRISIL Ratings has combined the business and financial risk profiles of KOEL and its manufacturing subsidiaries, including Kirloskar Americas Corp (100% subsidiary) and LGMPL (100% subsidiary effective September 2022, includes 100% step-down subsidiary Optiqua Pipes and Electricals Pvt Ltd [Optiqua; CRISIL BBB-/Watch Positive]). All the companies, collectively referred to herein as KOEL, have common management and operational linkages. For Optiqua’s 49% joint-venture entity, ESVA Pumps India Pvt Ltd, proportionate profits/losses are included.

 

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

 

For ARKA, CRISIL Ratings has used the capital allocation method and adjusted the networth of KOEL 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. 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 pump market.

 

KOEL has an established research and development (R&D) team, which has developed and launched new products complying with new emission norms, diversified and new fuel types, as well as HHP gensets and engines. While the government has extended delivery deadline of CPCB 4+ (applicable on engines up to 800 kilovolt ampere [kVA]) by a year to June 30, 2024, pre-buy of sunset CPCB 2 engines and retrofit emission control devices will support sales in fiscal 2024 with the new engines priced 20-30% higher than legacy ones. Being export-ready, the new engines will also boost overseas sales as the company expands its global footprint. 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. This will support healthy revenue growth while maintaining Ebitda margin over 10% over the medium term.

 

Strong financial risk profile

Adjusted gearing remained low at 0.12 time as on March 31, 2023 (0.21 time a year earlier), with gross debt of Rs 115 crore. Interest coverage ratio was around 29 times in fiscal 2023 and will remain healthy over the medium term. The financial risk profile will sustain, despite capex of around Rs 350 crore in fiscal 2024 and Rs 250 crore in fiscal 2025, on account of steady cash accrual. Larger-than-expected capex or acquisition, or significant investments in ARKA, affecting the liquidity or debt protection metrics of KOEL, will be 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. 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 30-40 crore annually over the next two fiscal. Capex of Rs 350 crore in fiscal 2024 and Rs 250 crore in fiscal 2025 will be funded through a mix of internal cash accrual and term debt. KOEL had liquid surplus of Rs 297 crore as on March 31, 2023. 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: Positive

CRISIL Ratings believes KOEL will improve its market penetration in HHP categories and overseas markets while sustaining its strong market position in the small and medium genset segments catering to diverse sectors. It will sustain its established market position in the agriculture and small pumps markets. The financial risk profile will remain strong, supported by robust capital structure and debt protection metrics.

Rating Sensitivity Factors

Upward Factors 

• Better-than-anticipated revenue growth and operating profitability sustained at 10-11%, driven by increasing share of exports and improving product mix, including through better penetration in HHP categories, benefitting cash generation
• Efficient working capital management and continued healthy financial risk profile
• 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 (below 8%), impacting cash generation
• Large, debt-funded capex or acquisition, or stretch in the working capital cycle, leading to higher debt, impacting key debt metrics
• Material reduction in liquid surpluses due to large dividend payout, share buyback or capital reduction, or additional investment in ARKA

About the Company

KOEL, one of the flagship companies of the Kirloskar group, manufactures and services diesel engines (primarily of 20-750 horsepower) and diesel generator sets (ranging from 2 kVA to 3,000 kVA). The company also makes diesel and electric pump sets. It has manufacturing units at eight locations in India, including Pune, Kagal, Rajkot and Nashik. It caters to the agriculture, power generation and industrial sectors.

 

For the first three months of fiscal 2024, on a consolidated basis (including ARKA), net profit was Rs 125 crore and operating income was Rs 1,543 crore, against Rs 82 crore and Rs 1,191 crore, respectively, in the corresponding period of the previous fiscal.

Key Financial Indicators*

Particulars	Unit	2023	2022
Operating income	Rs crore	4649	3817
PAT	Rs crore	263	168
PAT margin	%	5.7	4.4
Adjusted debt / adjusted networth	Times	0.12	0.21
OPBDIT interest coverage	Times	29.2	22.8

*CRISIL Ratings-adjusted consolidated numbers

Any other information: Not applicable