Detailed Rationale

CRISIL Ratings has reaffirmed its ratings on the bank facilities of Sarda Energy and Minerals Limited (SEML; part of the Sarda group) at ‘CRISIL AA-/Stable/CRISIL A1+’.

 

The ratings reflect healthy business risk profile of the company supported by stable performance in the steel business, expansion of Gare Palma coal mine from 1.20 million tonne per annum (MTPA) to 1.44 MTPA, as well as a strong financial risk profile supported by strong debt protection metrics, healthy cash accruals and strong liquidity.

 

The business risk profile has been supported by increase in the extraction capacity at Gare Palma coal mine from 1.2 MTPA to 1.44 MTPA and commissioning of a third furnace of 36 megavolt ampere (MVA) at Sarda Metals and Alloys Ltd [SMAL, a 100% subsidiary of SEML; rated CRISIL A/Stable/CRISIL A1] in line with earlier expectations. The expansion of Gare Palma coal mine has enabled the company to meet its entire standalone thermal coal requirements, hence supporting operating efficiency, which continues to benefit from the integrated nature of operations including captive iron ore mines. The business profile will further be supported by the commissioning of Shahpur and Kalyani coal mines over the medium term and further expansion in the extraction capacity at Gare Palma.

 

The company reported an increase of ~ 7% in the operating income to Rs 3,911 crore, in FY23 compared to FY22 supported by healthy utilisation rates. However, the operating profit before depreciation interest and taxes (OPBDIT) was lower by 25% mainly due to lower realizations and high energy costs during the fiscal. However, the said moderation was in line with expectations. With healthy domestic demand and easing energy prices, operating profitability of the company is expected to remain healthy over the medium term with operating margins around 19-22%. Further, no material capex other than the ongoing plans for commissioning of coal mines should support financial risk profile for the company.

 

The financial risk profile continues to be supported by strong debt protection metrics. The adjusted interest coverage ratio was at 21.44 times in FY23 (24.8 times in FY22) and the adjusted gearing ratio improved to 0.19 times in FY23 compared to 0.22 times in FY22. The cash accruals at the company are expected to be higher than the capital expenditure (capex) and debt repayment requirements. Moreover, the financial risk profile is expected to remain healthy over the medium term with adjusted interest coverage ratio expected to be above 15 times and the gearing ratio expected to be comfortably below 0.5 time.

 

That said, Crisil ratings notes that the company is one of the front runners for acquiring SKS Power Generation (Chhattisgarh) Ltd (SPGCL). On June 9, 2023, Sarda Energy and Minerals Ltd (SEML) had announced that the resolution professional of SKS Power Generation (Chhattisgarh) Ltd (SPGCL) declared the company as the successful resolution applicant for the latter. SPGCL has a 600 MW operational thermal power plant in Raigarh district of Chhattisgarh. However, NCLT, on October 6, 2023, has remanded the plan back to the committee of creditors to reconsider the resolution plan submitted by SEML. Further developments on the NCLT process along with clarity on the contours of the deal and operational plan for the asset, and its potential implication on the credit profile of SEML will need to be assessed in detail and shall be a key monitorable.

 

SEML has made investments in and provided loans and advances of ~Rs 1,149 crore as on March 2023 (35% of the net worth) - was ~Rs 1,239 crore as on March 2022 (44% of the net worth) - to subsidiaries and associates (excluding SMAL). CRISIL Ratings understands the company has no further plans to make any major investment in group entities. Indeed, most of the amount of loans and advances is callable and can be ploughed back into the company in case of any cash flow requirement.

 

The ratings reflect the established market position of the Sarda group, supported by diversified revenue streams and integrated nature of operations, and a strong financial risk profile. These strengths are partially offset by exposure to cyclicality in the steel and ferro alloy industries, and large investment in associate entities.

Analytical Approach

CRISIL Ratings has combined the business and financial risk profiles of SEML and SMAL, together referred to as the Sarda group. SMAL is a wholly owned subsidiary of SEML and both are engaged in the same line of business. Furthermore, SEML has guaranteed Rs 52 crore of the debt of SMAL (o/s debt against this guarantee is Rs. 25.21 crore as on March 31, 2023), and provided support to the latter through unsecured loans in the past. CRISIL Ratings has also moderately consolidated the subsidiaries, Madhya Bharat Power Corporation Ltd (MBPCL) and Chhattisgarh Hydro Power LLP (CHP LLP), in case SEML infuses funds in these entities over the medium term (as seen in the past). The remaining subsidiaries, joint ventures and controlled entities are treated as financial investments.

 

Please refer to Annexure - List of entities consolidated, which highlights entities considered and their analytical treatment for consolidation.

Key Rating Drivers & Detailed Description

Strengths:

Established market position: The group is one of the largest manufacturers of manganese-based ferro alloys in India and caters to the domestic and international markets. This is supported by the extensive experience of the promoters and a qualified management. Revenue is diversified across sale of intermediate and finished steel products, ferro alloys and surplus power from the captive power plants. Portfolio is backed by the ability to manufacture different grades of steel products and niche-grade manganese-based ferro alloy products.

 

Integrated nature of operations: Operations are backward integrated with a captive iron ore mine that meets 40-50% of the total iron ore requirement and captive power plants that meet total power requirements, leading to high operational efficiency. Integration has further improved after commissioning of the coal mine, which meets the entire requirement of thermal coal of SEML. Surplus power generated is traded on the Indian Energy Exchange. Flexibility of changing revenue mix within intermediate steel products and final products as well as power sales helps in successfully manoeuvring business cycles and sustaining operating margin. Procuring raw material in bulk helps save cost. Similarly, proximity of SMAL to the Vishakhapatnam port in Andhra Pradesh saves logistics cost and helps target global markets. Hence, operating margin has remained healthy at around 14% even during the downturn in fiscal 2016.

 

Strong financial risk profile: Debt protection metrics were robust, with adjusted interest coverage and net cash accrual to total debt ratios of 21.4 times and 1.09 times, respectively, in fiscal 2023 (24.8 times and 1.39 time, respectively, during fiscal 2022). Capital structure is comfortable, with gearing of 0.19 time as on March 31, 2023 (0.22 times as on March 31, 2022). Financial risk profile is expected to remain healthy due to high cash accruals and limited capex in existing steel and ferro alloys business. Crisil Ratings expects the adjusted interest coverage to be 14-16 times and 17-19 times and gearing to be below 0.20 time for FY24 and FY25 respectively. However, this does not factor in the potential impact of acquisition of SPGCL, which is currently sub-judice, and the impact of the same on the credit profile of SEML will need to be assessed once the clarity emerges on the legal process and contours of the deal. Further developments on this front will be rating sensitivity factor.

 

Weaknesses

Exposure to cyclicality in the steel and ferro alloy industries: These are closely linked to the domestic and global economies as growth depends on the level of construction and infrastructure activities. Any downturn in the economic cycle adversely impacts demand, as was seen in fiscal 2016. Furthermore, any change in government policies on imports/exports affects the industries (exports contribute 20-30% to the group revenue). In addition to demand risk, the industries remain exposed to volatility in raw material prices and finished product realisations, which can impact operating margin. The prices are largely subject to global commodity prices. However, this is partially offset by the integrated nature of operations, flexibility in changing revenue mix between steel and steel intermediates, ferro alloys and power, and ability to pass through any change in raw material prices to customers. Any significant variation in demand and pricing scenario will remain a key monitorable.

 

Substantial investment in subsidiaries and group entities: Equity investments and loans and advances in group entities (including associates, joint ventures and controlled entities excluding SMAL) were around Rs 1,149 crore as on March 31, 2023 (~Rs 1,239 crore as on March 2022). These investments are largely in unrelated businesses (such as hydro power) and in entities with weaker credit risk profiles as well as back-ended returns. CRISIL Ratings understands that no further investments needed in the said entities. However, any major increase in loans and advances that may impact financial risk profile of SEML will remain a key rating sensitivity factor.

Liquidity: Strong

Liquidity stood at Rs 715 crore (including investments in liquid mutual funds, shares and bonds & debentures) while unutilised bank limit was Rs 240 crore, as on August 2023. Net cash accrual is expected at about Rs 500 crore in fiscal 2024 which, along with existing liquidity, should be adequate to meet debt obligation and capex.

Outlook: Stable

The group will continue to benefit from its established market position in key long steel products and ferro alloys, diversified revenue streams and integrated nature of operations, thereby ensuring healthy cash generation; financial risk profile is likely to remain strong over the medium term.

Rating Sensitivity Factors

Upward factors

• Healthy operating performance with continued volume growth supported by high-capacity utilisation; and operating margin of 25-30% due to increased integration leading to significant and sustained improvement in scale of operations as well as net cash accruals.
• Substantial and steady improvement in financial risk profile with no material debt-funded capex or acquisition; and better liquidity with reduction in exposure to group entities and maintenance of higher cash surplus on balance sheet

 

Downward factors

• Deterioration of operating performance due to weakened demand and intense competition leading to fall in margin to below 15-18% on sustained basis, thereby materially reducing cash accrual
• Any significant increase in exposure to group entities weakening liquidity
• Large, debt-funded capex or acquisition adversely affecting financial risk profile

About the Group

Based in Chhattisgarh, the Sarda group is promoted by Mr Kamal Kishore Sarda, who manages operations with his son, Mr Pankaj Sarda, and a team of professionals. The group manufactures iron pellets, sponge iron, billets, wire rods and wires, along with ferro alloys and eco-friendly fly ash brick. The group has thermal power plants and a waste-heat recovery boiler to generate power that is largely used for captive consumption.

 
SEML, incorporated in 1973, is the flagship company of the group. It is a vertically integrated producer of steel with captive iron ore and commercial coal mines. It also manufactures and exports niche-grade manganese-based ferro alloys, with self-sufficient captive power from waste heat and coal.

 

SMAL, incorporated in October 2008, is a wholly owned subsidiary of SEML and operates a 2x33-MVA plus 36 MVA ferro alloys plant, backed by an 80-megawatt captive thermal power plant.

 

The group also has interests in hydropower projects through special project vehicles, MBPCL, CHP LLP and Parvatiya Power Ltd.

Key Financial Indicators - Consolidated*

Particulars	Unit	2023	2022
Operating income	Rs crore	3,911	3,652
Profit after tax (PAT)	Rs crore	619	807
PAT margin	%	15.8	22.1
Adjusted debt/adjusted networth	Times	0.19	0.22
Adjusted interest coverage	Times	21.4	24.8

*As per analytical adjustments made by CRISIL Ratings

Any other information: Not applicable