Key Rating Drivers & Detailed Description
Strengths:
Strong market position with track record of executing complex and large projects
MEIL is the second-largest EPC player in terms of revenue and the largest EPC player in irrigation and drinking water works in India. MEIL has shown ability to diversify to several sectors such as hydrocarbons, roads, power, buildings, railways etc. The business spans a spectrum of projects, ranging from complex turnkey EPC projects to simple construction activities. In-house design, engineering and fabrication capabilities for critical equipment and systems give a strong competitive advantage. Strong competencies across segments and sectors along with a track record of completing projects as per specifications have led to a robust brand image in India.
MEIL has established relationships with various state government departments by virtue of its track record of over two decades in the construction industry and timely project execution. The company mainly bids for projects floated by various government bodies. The company has a fleet of construction equipment, which enables it to bid competitively for several projects.
The strong project execution capability is reflected in successful completion of projects within the scheduled time and budgeted cost. The strong in-house EPC division undertakes all project implementation. Over the past decade, MEIL leading position in the domestic EPC segment is supported by executing complex and large projects including prestigious projects such as WUPPTCL, Kaleshwaram Lift Irrigation Project, Polavaram project, Assam Refinery project and the ongoing Zojila tunnel project amongst others. As a result, the consolidated revenue has grown at a five-year CAGR of ~24% to around Rs 22000 crore in fiscal 2021.The company also has undertaken projects in several countries such as Kuwait, Tanzania, Jordan, Zambia, and Rwanda.
Improving diversity in revenue and order book
The revenue visibility of the group is strong backed by healthy outstanding order book of ~Rs 1.3 lakh crore as on October 31, 2021 with 55% of the orders pertaining to irrigation and drinking water segments. The company has received orders of Rs 32150 crore upto 31.10.2021 in fiscal 2022 led by hydrocarbons (~43%), irrigation and drinking water (42%) and the rest from power and building segment.
Majority of the outstanding orders are from domestic projects with reducing share of its earlier focused States of Andhra Pradesh and Telangana in outstanding order book from ~70% in past fiscals to ~50% in current fiscal. This reflects diversification of revenue across segments and states in India, majorly on account of the company’s continuous focus on increasing its presence across the country.
Similarly, MEIL had been focusing on diversifying its order book across various segments along with maintaining its position as a market leader in irrigation and drinking water segments. At the end of October 2021, 55% of the overall order book comprised of irrigation projects compared to 82% in fiscal 2018. In the current fiscal, MEIL derived ~43% of the overall new order from the hydrocarbon sector, thus demonstrating its increased focus to reduce geographical and segmental concentration.
Going ahead, the order book is expected to grow 10-12% and overall revenue growth would be driven by hydrocarbons which is expected to be the new focus area for MEIL under EPC segment. CRISIL Ratings expects MEIL will register healthy double digit revenue growth over the medium term.
Healthy operating efficiency supported by backward integrated operations
On a consolidated basis, MEIL’s operating margin has sustained at 16-18% since fiscal 2016. The company has set up backward integration facilities for engineering and fabrication capabilities for critical equipment and systems including manufacturing different types of pipes and pressure vessel division. This has helped in sustenance of stable operating margins in the last five fiscals despite competitive pressure. Similarly, MEIL is focused on reducing subcontracting expenses and hedging price of commodities such as steel by entering long-term contracts with large steel manufacturers with price variation clauses for a major portion of its order book.
Over the medium term, the focus will be on hydrocarbon projects which have higher margin and lower working capital requirement compared to irrigation projects. This will result in better overall operating profitability for MEIL over the medium term.
Comfortable financial risk profile
MEIL’s financial risk profile is comfortable, supported by sizeable net worth of Rs 15,674 crore as on March 31, 2021 which is expected to improve to above ~Rs 18000 crore in fiscal 2022. MEIL’s strong cash generating ability, supported by healthy profitability, has ensured low debt requirement, despite sizeable investments in diverse business segments and capex. MEIL has undertaken capex of Rs 4648 crore (including acquisitions) since fiscal 2019 and investments were Rs 1126 crore in fiscal 2021.
Debt protection metrics were healthy - gearing and TOL/TNW ratio were at 0.18 time and 1.08 times respectively as on March 31, 2021 and estimated at 0.19 time and 0.96 time respectively in fiscal 2022. While interest coverage and NCA/TD rations were ~7 times and 0.89 time respectively in fiscal 2021. It is expected to be 6.18 times and 0.83 time respectively in fiscal 2022.
MEIL intends to finance its four HAM projects largely through internal accruals. The company is expected to invest Rs 3000-4000 crore in fiscal 2023 for inorganic expansion, which will involve part debt funding. Total debt is likely to increase from Rs 2850 crore in fiscal 2021 to Rs 6000-7000 crore over the medium term at consolidated level. However, due to strong annual cash generation of ~Rs.3500-4000 crores, the debt protection metrics will remain healthy over the medium term - Interest coverage ratio is expected to be more than 6 times, NCATD at above 0.50 times, and TOL/TNW ratio being range bound at 1-1.2 times.
Some of the past major investments of MEIL such as WUPPTCL and SEPC are expected to witness healthy performance over the medium term which would support the overall cash flows of MEIL. The company may explore option to monetise the HAM assets through InvIT or avail debt by escrowing these cash flows based on requirement. On a similar construct, MEIL may escrow WUPPTCL’s cash flows and avail bank loan to effectively manage its liquidity. CRISIL Ratings believes MEIL will maintain at least Rs 2000 crore unencumbered cash in the form of fixed deposits, mutual funds and utilization of fund-based limit to remain minimal.
Weaknesses
Investments in unrelated businesses and group companies
MEIL has a complex structure with more than 35 subsidiaries, 4 SPVs and other associate concerns. MEIL has been venturing into new businesses such as EVs, EV bus operations and city gas distribution, which compared with existing EPC business require separate set of skills. Though MEIL has showcased ability to take diverse projects in the past within the EPC segment, different from its core capability of undertaking irrigation and drinking water projects, the new business is outside the EPC purview. The successful implementation and performance of these businesses would be critical, to ensure limited drain on the resources generated by MEIL. The Company has also expressed intent to participate in bidding for PSU organizations such as Shipping Corporation, Bharat Earth Mover Ltd etc. and suitable assets via IBC route.
The company has divested its stake in its distressed loss-making assets- HKR Roadways Pvt Ltd and Nagai Thermal Power Project, in the current fiscal. Both entities are no longer associated with the MEIL group. As a result, its negative impact on cost of borrowings or credit profile of MEIL is expected to reduce resulting in cost savings.
Currently, the investments in group companies during fiscal 2021 are at 8.1% of the consolidated net worth. Some of these investments such as WUPPTCL have started generating healthy return on capital employed however on combined basis return on these investments remained low. Any substantial increase in investments in group companies constraining return metrics would be a key monitorable.
Susceptibility to intense competition and cyclicality in the construction industry
MEIL is exposed to cyclicality inherent in the EPC industry and volatility in profitability amid intense competition in the EPC segment.
Of the order pipeline as of October 2021, the irrigation and drinking water accounted for 55% and the remaining were from the other infrastructure segment. With the increasing focus of the central government on the infrastructure sector, MEIL is expected to reap benefits over the medium term. However, most of its projects are tender-based and face intense competition, which may require it to bid aggressively to get contracts. Also, given the cyclicality inherent in the EPC industry, the ability to maintain profitability margin through operating efficiency becomes critical.
Working capital intensive operations
The working capital requirement is inherently high in the EPC industry, given the dependence on state and central government authorities for timely receipt of payments. The gross current assets (GCAs) were high at 213 days mainly due to high debtors of 118 days as on March 31, 2021. Debtors are largely in form of receivables and retention money from ongoing and past projects which are expected to come down gradually. Other current assets including advances to sub-contractors and encumbered cash are increasing over last few years and hence the GCA have been 150 to 230 days over the last five years. MEIL has been funding this through large advances which has remained 25% of the overall gross current liabilities.
Going ahead, the management’s intention to focus on collection and judicious bidding for new projects with lower working capital intensity should keep the overall working capital requirements under control. With this, GCAs are expected to decline gradually over the medium term.