Detailed Rationale

CRISIL Ratings has continued its ratings on the bank facilities of SEPC Ltd (SEPC) on ‘Rating Watch with Developing Implications’.

 

The ratings were placed on ‘Developing Watch’ in October 2023 following the interim order of the Madras High Court in relation to the legal proceeding involving Twarit Consultancy Services Pvt Ltd (TCPL), GPE (INDIA) Ltd, GPE JV Ltd, Gaja Trustee Company Pvt Ltd (collectively called Gaja), restraining SEPC from withdrawing amounts from certain bank accounts mentioned in the order (totalling Rs 33.07 crore), except those which are subject to lien.

 

CRISIL Ratings continues to hold discussions with SEPC and its lenders, and notes that there has not been any material impact of the restraint order on the company’s liquidity, finances and operations. CRISIL Ratings also notes the successful completion of the Rs 49.9 crore rights issue in December 2023, further plans to raise additional Rs 250 crore in rights issue and continuing support from the new promoters, which has improved the company’s liquidity and supported its working capital management. CRISIL Ratings will continue to monitor developments and remains in discussion with the management and lenders of SEPC. Adverse regulatory action, including punitive action, or any action by the lenders, which may have a bearing on the credit risk profile of SEPC or the expected ramp-up in operations, will remain monitorable.

 

The ratings continue to reflect the moderate business risk profile of SEPC, given its established position in mid-sized engineering, procurement and construction (EPC) across water, process and metallurgy (P&M) segments, its healthy order book and long-track record of operations. The ratings are, however, constrained by large working capital requirement and intense competition in the EPC industry.

 

SEPC’s financial risk profile remains average and is improving gradually since the implementation of the resolution plan on September 30, 2022, with Mark AB Capital Investment LLC (Mark AB) replacing the previous promoters and holding 29.6% stake (including their welfare trust) in the company. Mark AB has infused Rs 350 crore in equity, which has been used to repay debt, and is committed to provide additional non-fund-based lines to support working capital needs.

 

CRISIL Ratings also notes that the lenders have converted Rs 175 crore debt into compulsorily convertible debentures (CCDs) with conversion in fiscal 2035 (treated as quasi-equity as per the CRISIL Ratings analytical approach) and another Rs 175 crore into non-convertible debentures (NCDs) with comfortable stepped-up repayment schedule (repayment of only Rs 0.87 crore annually till 2027). The effective interest rate on the NCDs and CCDs is ~4% (with a step-up mechanism from 0.1% interest rate in the first two years) while the remaining term loans have effective interest rate of ~9%. The successful completion of rights issue totalling ~Rs 100 crore in April and December 2023 and extended repayment schedule have helped strengthen the capital structure and debt protection metrics. Adjusted gearing was 0.29 time as of September 2023 compared with 1.2 times as of March 2022.

 

Healthy order execution resulted in increase in standalone revenue to Rs 242 crore in the first six months of fiscal 2024 with earnings before interest, taxes, depreciation and amortisation (Ebitda) of Rs 22 crore and operating margin of 8.1%. The order execution and revenue booking are expected to pick up in the second half of the year. Standalone revenue had risen 24% in fiscal 2023 driven by improved execution, mainly in the water segment from the third quarter, and successful implementation of the resolution plan, on the low base of the previous fiscal when the operations were impacted by liquidity issues and debt restructuring. Gross current assets (GCAs; including unbilled revenue) remained high, at 1,354 days as on March 31, 2023, compared with 1,420 days a year earlier. The company had an order book of Rs 920 crore as on September 30, 2023, with healthy bid pipeline of over Rs 3,000 crore. Ability to grow and generate cash is contingent on healthy execution of older orders and timely collection from counterparties, and will remain monitorable.

Analytical Approach

• CCDs of Rs 175 crore have been treated as equity as they will be compulsorily converted to equity and will remain in the company for long (with redemption only in fiscal 2035), carrying effective yield of 4%. NCDs of Rs 175 crore held by the lenders as per the resolution plan have been treated as debt.
• The cash flows from subsidiaries are not incorporated in the projections as there are no committed or financial obligations or inflows related to these subsidiaries. Additionally, these subsidiaries do not have any fund-based and non-fund-based debt.

Key Rating Drivers & Detailed Description

Strengths:

• Established market position with a long track record in the mid-sized EPC business: SEPC (standalone) has an established market position among mid-sized EPC contractors, backed by execution track record of more than two decades and established relationships with clients in both, the water and P&M segments, in India and abroad. In the water segment, the company primarily executes projects in the water and waste-water distribution and water treatment areas, where it has executed large contracts for Indian clients, including various state water supply and urban infrastructure departments as well as several overseas clients. In the P&M segment, it has executed several large and marquee projects, including a cement and limestone handling system plant for Sree Jayajothi Cements Ltd, a coal chemical plant for SAIL (Rourkela), and a new turnkey circular shaft with complete winding installation project for Hutti gold mines in Raichur district of Karnataka.

 

• Stable business risk profile reflected in the order book in the water segment: SEPC had an order book of Rs 920 crore as on September 30, 2023, as against Rs 1,143 crore as on March 31, 2023. The company has also bid for orders of over Rs 3,000 crore. Water projects of Rs 946 crore comprised 83% of the order book as of March-2023, and a large portion were in advanced stage of execution and expected to be completed in fiscal 2024, supporting strong revenue growth. Ability to sustain healthy growth will depend on bids won across segments and will remain a key monitorable.

 

• Experienced and capable new management, in Mark AB, who will be the single largest shareholder in the company: Though Mark AB is new to the Indian markets, it has considerable experience in investing and managing EPC businesses around the world, including in Russia, Algeria and Kuwait. Its experience in the EPC business in the Middle East will help bring in globally accepted best practices to SEPC for timely project execution. Mark AB has taken over the existing operational and management control of SEPC, and its sound technical qualifications will lead to a seamless transition. Mark AB has access to a network of partners, both construction and technology, which will enable SEPC to increase business volume by bidding for projects that it would otherwise not qualify for (for instance, oil and gas). Mark AB has already invested equity of Rs 350 crore and infused Rs 9 crore for working capital, and is in advanced stage to infuse additional fund-based and non-fund-based working capital limts, besides providing corporate guarantee for SEPC’s lenders. Mark AB will likely provide emergency support to SEPC, as and when required.

 

Weaknesses:

• Working capital-intensive operations: Given SEPC’s presence in the EPC business with focus on water and P&M segments, its operations have remained working capital intensive. Given that the company was under financial stress with limited working capital lines, it faced execution and completion delays, which have led to a considerable increase in working capital while revenue remained constrained. The GCAs surged to 1,354 days as on March 31, 2023, from 629 days as on March 31, 2019, as unbilled revenue shot up to 663 days from about 500 days, with receivables increasing to 409 days. Working capital support from bankers and the new promoters and steady execution of older projects should lead to improvement in the working capital cycle, though it will remain large and a key monitorable.

 

• Modest financial risk profile: The total outstanding debt at SEPC (standalone) was Rs 330 crore (including Rs 175 crore NCDs) as on September 30, 2023, at the same level as on March 31, 2023, having reduced from Rs 891 crore as on March 31, 2022. Networth rose to ~Rs 1,140 crore as on September 30, 2023, from Rs 746 crore as on March 31, 2022, post the restructuring, equity funding from Mark AB and rights issues. Consequently, gearing improved to ~0.29 time as on September 30, 2023, from 1.2 times as on March 31, 2022. SEPC is likely to undertake only moderate capital expenditure of up to Rs 4-5 crore annually over the medium term at the standalone level, which is expected to be funded through internal accrual. With steady ramp-up in project execution and cash accrual, there should be steady accretion to networth resulting in gradual improvement in credit metrics.

 

• Susceptibility of profitability to volatility in raw material prices: Profitability is susceptible to fluctuations in the prices of polyethylene, polyvinyl chloride, polymer resin (for water segment) pipes, which are among the key components used in the water segment projects. These products are commodities and their prices are determined by the demand-supply scenario and the price of petroleum. While SEPC is able to pass on the price volatility to customers for a large portion of its sales, its profitability remains susceptible to volatility in raw material prices for fixed price contracts.

Liquidity: Adequate

SEPC has met all its debt obligations till March 2023. The company has sanctioned fund-based bank limit of Rs 157.1 crore, which was utilised extensively at 88%, on average, over the six months through November 2023. The utilisation has improved with successful completion of the ~Rs 50 crore rights issue in December 2023 and is expected to improve further once additional Rs 250 crore rights issue announced on January 29, 2023 is completed. The non-fund-based limit of 709.3 crore was utilised 66%, on average, over the six months through November 2023. CRISIL Ratings notes that SEPC has scaled up operations over the period while maintaining the utilisation level. The company had moderate liquid surplus of Rs 39 crore as on September 30, 2023.

 

CRISIL Ratings also notes that there is an agency for specialised monitoring (ASM) appointed by the lenders since fiscal 2014, as part of the corporate debt restructuring (CDR) plan, to provide for funds for timely debt servicing. A trust and retention account (TRA) is being maintained by the lenders, wherein cash flow from operations is parked in advance for forthcoming debt obligations, and the balance is permitted to be utilised by the company. Continuation of the ASM led monitoring of the TRA along with one quarter of debt obligation as DSRA will support timely debt servicing.

 

SEPC is likely to generate cash accrual of Rs 60 crore in fiscal 2024 and over Rs 120 crore in fiscal 2025, which will be sufficient to cover the debt obligation of ~Rs 2.6 crore in fiscal 2024 and Rs 4.2 crore in fiscal 2025 as well as capex. Besides, SEPC has received Rs 9 crore from Mark AB and is expecting additional fund and non-fund-based limits during fiscal 2024, which will aid its working capital needs.

Rating Sensitivity factors

Upward factors:

• Substantial improvement in revenue while generating consistent operating profit of 7-8%.
• Sharp improvement in the working capital cycle resulting in improved liquidity cushion.
• Strong improvement in leverage led by additional equity infusion or better operational performance.

 

Downward factors:

• Less-than-expected growth in revenue with operating margin remaining below 3% impairing net cash accrual.
• Sustained stretch in the working capital cycle impacting liquidity.
• Weakening in credit metrics or liquidity owing to non-provisioned claims, liabilities or payments arising from legal disputes.

About the Company

SEPC (Shriram EPC Ltd till February 2021) was incorporated in June 2000. The company became majority owned by Mark AB since September 2022 post infusion of Rs 350 crore. SEPC specialises in executing EPC contracts, providing integrated solutions encompassing design, engineering, procurement, construction and project management services in water, process and process and metallurgy, and infrastructure segments.

 

Mark AB is the largest stakeholder in SEPC, with 29.6% stake as on March 31, 2023.

 

For the first six months of fiscal 2024, SEPC had a net profit of Rs 10 crore and operating income of Rs 272 crore compared with a profit of Rs 4 crore and operating income of Rs 114 crore during the corresponding period of the previous fiscal.

Key Financial Indicators (CRISIL Ratings-adjusted figures)

As on/for the period ended March 31	Unit	2023	2022
Operating income	Rs crore	379	305
Profit after tax (PAT)	Rs crore	(11)	(249)
PAT margin	%	-2.99	-81.5
Adjusted debt/adjusted networth	Times	0.30	1.20
Interest coverage	Times	NM	NM

NM – not meaningful

Status of non cooperation with previous CRA

SEPC has not cooperated with India Ratings And Research Private Limited (Ind-Ra), who have classified the company as non-cooperative through release dated September 08, 2017. The reason provided by Ind-Ra is non-participation in the rating surveillance exercise.

Any other information: Not Applicable