Detailed Rationale

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

 

The rating action follows a news article dated October 20, 2023 regarding a recent Madras High Court interim order in relation to SEPC’s ongoing legal proceeding involving Twarit Consultancy Services Private Limited and GPE (INDIA) Ltd, GPE JV Ltd, Gaja Trustee Company Private (cumulatively called ‘Gaja’), wherein the court has restrained SEPC from withdrawing amounts from certain bank accounts mentioned in the order (cumulating to Rs 33.07 crore); except those which are subject matter of lien. CRISIL Ratings has held discussion with both the company as well as lenders, wherein it understands that there may not be any immediate impact on the company’s liquidity, finance and operations. CRISIL Ratings will continue to monitor this event wherein any adverse regulatory action, including punitive action, or any action taken by the lenders, which may have a bearing on the credit risk profile of SEPC or the expected ramp-up in operations, will remain key rating monitorables.

 

The ratings continue to reflect the moderate business risk profile given established position of SEPC in mid-sized Engineering, Procurement and Construction (EPC) industry across water, process & metallurgy (P&M) segments, healthy orderbook, and long-track record of operations. The ratings are, however, constrained by high working capital needs and intense competition in the EPC industry. Besides, SEPC’s financial risk profile has improved but remains moderate and is gradually improving since the implementation of the resolution plan on September 30, 2022, with new promoters, “Mark AB Capital Investment LLC (Mark AB)” replacing the previous promoters, and now holding majority 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 further committed to provide additional non-fund-based lines to support the working capital needs.

 

CRISIL Ratings also notes that the lender’s have converted Rs 175 crore debt into Compulsorily Convertible Debentures (CCDs) with conversion in fiscal 2035 (treated as quasi-equity by CRISIL Ratings as per analytical approach) and another Rs 175 crore into Non-Convertible Debentures (NCDs) with comfortable stepped-up repayment schedule (repayment of only 0.87 crore annually till 2027). The effective interest rate on NCD and CCD is ~4% (with a step-up mechanism having 0.1% rate in first 2 years) while the remaining term loans have effective interest rate of ~9%. Along with the successful completion of Rs 49.9 crore rights issue in April-2023, SEPC’s capital structure has strengthened with adjusted gearing of 0.29 times as compared to 1.2 times as of March-2022, with an extended repayment schedule, and improved debt protection metrics.

 

SEPC’s standalone revenue has grown to Rs 143 crore in the first quarter of fiscal 2024 with EBITDA of Rs 13 crore at 9.1% margin through healthy order execution. Previously, standalone revenue registered a 24% increase in fiscal 2023 driven by improved execution mainly in Water segment from third quarter onwards with successful implementation of the resolution plan, on a low base of previous fiscal when the operations were impacted by liquidity issues and ongoing debt restructuring. SEPC’s Gross Current Assets (GCA) days (including Unbilled Revenue) remained high as of March-2023 at 1354 days as compared to 1420 days last year. The outstanding orderbook of SEPC was Rs 1143 crore as on March 31, 2023 with healthy bid pipeline in excess of Rs 3,000 crore. SEPC’s ability to grow and generate cash is contingent on healthy execution of older orders and timely collections from the counterparties and will remain a key monitorable for growth over the medium term.

Analytical Approach

• The compulsory convertible debentures of Rs 175 crore have been treated as part of ‘equity’ as they will compulsorily get converted into equity, will remain in the company for long with redemption only in fiscal 2035 carrying effective yield of 4%. The Rs 175 crore of NCDs (Non-Convertible Debentures) held by lenders as per resolution plan have been treated as part of ‘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 don’t have any fund based and non-fund debt outstanding.

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 the mid-sized EPC contractors having a execution track record of more than two decades and established relationship with clients in both water and P&M segments in India and overseas. In the water segment it 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 several overseas clients. In the P&M segment, it has executed several large and marquee projects which included a Cement and limestone handling system plant for Sree Jayajothi Cements Ltd, a coal chemical plant for SAIL (Rourkela), new turnkey circular shaft with complete winding installation project for Hutti gold mines in Raichur district of Karnataka, among others.

 

• Stable business risk profile reflected in the order book in water segment

The order book of SEPC stood at Rs 1143 crore as on March 31, 2023. Additionally, company has also bid for sizeable orders of over Rs 3,000 crore. The outstanding orderbook had Water projects of Rs 946 crore (83% of the total orderbook), large portion of which is in advanced stages of execution and which is expected to be completed in fiscal 2024 supporting the strong revenue ramp-up. Going forward, company’s ability to sustain healthy growth will depend on healthy bid wins 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, Russia, Algeria, and Kuwait. Its experience in the EPC business in the Middle-East would help to bring in globally accepted best practices to SEPC for timely project execution. Besides, Mark AB has taken over the existing operational and management  control of SEPC, as per plan implenenatation terms, which has vast experience in the EPC business along with sound technical qualifications for a seamless transition. Mark AB’s access to a network of partners, both construction and technology, is expected to enable SEPC to increase business volumes by bidding for projects that it would otherwise not qualify (e.g.: Oil and Gas). Mark AB has already invested Rs 350 crore in equity, infused Rs 9 crore funds for working capital and is in advanced documentation to infuse additional non-fund based working capital limts, besides providing for corporate guarantee for SEPC’s lenders. Mark AB is expected to provide any 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, SEPC’s operations have remained working capital intensive. However, with constrained working capital lines given the company was under financial stress with limited working capital lines, it faced execution and completion delays which have led to working capital increasing considerably while scale remained constrained. In fiscal 2023, the unbilled revenue days shot up to 663 days from about 500 days in fiscal 2019 with debtors increasing to 409 days resulting in GCA days increasing to 1354 days from 629 days in fiscal 2019. With working capital support from bankers and new promoters and steady execution of older projects should lead to improvement in working capital, albeit will remain at elevated levels and remain a key monitorable.

 

• Modest financial risk profile

The total outstanding debt at SEPC (standalone) has reduced to Rs 330 crore (including Rs 175 crore NCDs) as on March 31, 2023 from Rs 891 crore last year while net worth has improved to Rs 1084 crore from Rs 746 crore during the same period, post the res-structuring and equity funding from Mark AB. With rights issue of Rs 49.9 crore in April-2023, net worth has further improved with gearing improving to 0.29 times in April-2013 from 1.2 times as of March-2022. SEPC is expected to incur only moderate capital expenditure of upto Rs 4-5 crore annually at standalone level, which is expected to be funded from internal accruals over the medium term. With steady ramp-up in projects execution and cash accrual generation, there should be steady accretion to net worth resulting in gradual improvement in credit metrics going forward.

 

• Susceptibility of profitability to volatility in raw material prices

The company is exposed to fluctuations in the prices of polyethylene, polyvinyl chloride, polymer resin (for water segment) pipes which are one of the key components used by it in the water segment projects. These products are commodities whose prices are determined by their respective demand-supply scenario and by the price of petroleum. While SEPC is able to pass on the price volatility to customers for large portion of its sales, its profitability still remains exposed to the raw material price volatility for fixed price contracts.

Liquidity: Adequate

SEPC has successfully met all its debt repayment and interest obligations till March 2023. The company sanctioned fund-based bank limit of Rs.157.1 crore continues to be highly utilised at 90% on average over the past 6 months through May 2023 while the non-fund based limits of 709.3 crore are on-average utilised 63% during the same period; however, CRISIL Ratings notes that company has been able to grow its scale of operations over this period while maintaining the same utilisation level. The company also had moderate liquid surplus of Rs 50 crore as on March 31, 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 CDR plan, to provide for funds for timely debt servicing. A trust and retention account (TRA) is being maintained by lenders, wherein cash flows from operations are parked in advance, against forthcoming obligations, and the balance is permitted to be utilised by the company. Continuation of the ASM led monitoring of the TRA along with 1 quarter of debt obligations as DSRA provides comfort around timely debt servicing.

 

The cash accrual from SEPC is expected at about 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 and also fund capex. Besides, while SEPC has received Rs 9 crore from Mark AB and is expecting additional non-fund based limits during the first half of fiscal 2024 which will aid its working capital needs.

Rating Sensitivity factors

Upward factors:

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

 

Downward factors:

• Lower than expected improvement in revenue with operating margins remaining below 3-4% impairing net cash accruals.
• Sustained stretch in the working capital cycle impacting liquidity
• Deterioration in credit metrics or liquidity position owing to non-provisioned claims, liabilities or payments arising out of legal disputes

About the Company

SEPC (formerly known as Shriram EPC Limited till Feb 2021) was incorporated in June 2000. SEPC’s became majority owned by Mark AB since September-2022 post infusion of Rs 350 crore. The company specializes 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.

The promoters held 29.6% stake in the company as on March 31, 2023.

 

For the first quarter of fiscal 2024, the company’s profit/(loss) after tax (PAT) stood at Rs 5 crore on operating income of Rs 143 crore as compared to PAT loss of Rs 38 crore on operating income of Rs 59 crore during the same period last fiscal.

Key Financial Indicators (CRISIL Ratings Adjusted figures)

As on / for the period ended March 31 Unit 2023 2022 Operating income Rs Crores 379 305 PAT Rs Crores (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 Credit Analysis and Research Ltd (CARE) and India Ratings And Research Private Limited (Ind-Ra), who have classified the company as non-cooperative through release dated April 03, 2023, and September 08, 2017, respectively. The reason provided by CARE is non-payment of surveillance fees and that provided by Ind-Ra is non-participation in the rating surveillance exercise.

Any other information: Not applicable

Annexure - Details of Instrument(s)

ISIN	Name of Instrument	Date of allotment	Coupon rate (%)	Maturity date	Issue size (Rs Cr)	Complexity levels	Rating Assigned with outlook
NA	Cash Credit	NA	NA	NA	157.05	NA	CRISIL BBB-/Watch Developing
NA	Term Loan	NA	9%	Mar-27	15.8	NA	CRISIL BBB-/Watch Developing
NA	Term Loan	NA	9%	Mar-29	6.6	NA	CRISIL BBB-/Watch Developing
NA	Term Loan	NA	0%	Mar-27	1.4	NA	CRISIL BBB-/Watch Developing
NA	Letter of Credit	NA	NA	NA	233.26	NA	CRISIL A3/Watch Developing
NA	Bank Guarantee	NA	NA	NA	476.04	NA	CRISIL A3/Watch Developing