Detailed Rationale

CRISIL Ratings has downgraded its rating on the long-term bank facilities and non-convertible debentures of Sterlite Technologies Ltd (STL) to ‘CRISIL AA-‘ from ’CRISIL AA’ while revised its rating watch to ‘Rating Watch with Developing Implications’ from ‘Rating Watch with Negative Implications’. The rating on the commercial paper programme continues on ‘Rating Watch with Developing Implications’. The continuation of rating watch is on account of the proposed demerger of the company’s global services business into STL Networks Ltd (resulting company), for which the company received board approval on May 17, 2023. The demerger is intended to simplify business structure, unlock growth opportunities and allocate efficient capital structure. The company is getting requisite approvals for the proposed transaction.

 

The downgrade factors in slower-than-expected recovery in operating performance, resulting in weak EBITDA (earnings before interest, taxes, depreciation, and amortisation) for the last few quarters. For the first quarter of fiscal 2025, STL reported only marginal improvement with revenues of Rs 1,218 crore and operating EBITDA of Rs 88 crore (EBITDA margin of 6.9%) compared to Rs 1,140 crore and Rs 54 crore respectively in the previous quarter. Consequently, the return on capital employed (ROCE) also remained subdued for fiscal 2024.

 

The impact on business risk profile stems from decline in global demand and decline in volumes. North America, which contributed ~38% of the revenues in fiscal 2023 before declining to 22% in fiscal 2024, continues to remain sluggish due to significant inventory buildup at the telcos. The marginal recovery in the first quarter of fiscal 2025 was driven by improvement in optical attachment rate having higher margins and marginal recovery in volumes. Overall, the low demand and consequent low capacity utilisation has impacted the operating profitability.

 

The long term industry outlook however remains favorable due to need of fiberisation across geographies to connect through high speed internet and improve 5G penetration. The company continues to have a healthy order book of Rs. 9,883 crore as of June 2024, which provides revenue visibility over the medium term. CRISIL Ratings estimates a significant recovery in operating performance in the second half of fiscal 2025. This will be driven by likely demand recovery in the North America market with significant inventory digestion at customers end. STL has also participated in the bids of large orders like BharatNet phase 3 which can start contributing from fourth quarter of this fiscal basis the order book from the project. While the US BEAD programme has been delayed slightly, a good recovery is expected from the programme starting next fiscal.

 

Slower than expected recovery in operating performance has impacted the financial risk profile as well. Net leverage (net debt to Ebitda ratio) was elevated at around 4.7 times for fiscal 2024 compared to 3.2 times in fiscal 2023 and interest cover deteriorated to 1.7 times for fiscal 2024 compared to 3.2 times in fiscal 2023. The company had raised equity of ~Rs 1,000 crore in April 2024 with the proceeds utilised towards deleveraging resulting in the improvement in the financial risk profile. However, net leverage is likely to remain elevated at 3-3.5 times interest cover is likely to remain modest for fiscal 2025 due to subdued profitability. Turnaround in operating performance leading to further improvement in financial risk profile going forward will be monitorable.

 

A portion of the rated facilities (including a portion of the enhanced facilities) may move to the demerged entity, subject to requisite approvals. CRISIL Ratings believes that credit risk profile of STL is likely to benefit from the proposed demerger because the services business has lower operating margin and higher working capital requirements relative to the products business staying under STL. On the other hand, the credit profile of the resulting company could be relatively weaker vis-à-vis STL. Thus, CRISIL Ratings will continue to closely monitor the transaction and resolve the rating watch once there is clarity on the resulting business and financial risk profiles of both entities and on the movement of the rated facilities.

 

CRISIL Ratings takes into cognisance the provisional anti-dumping duty of 11.4% levied on STL’s India entities and another domestic competitor by the European Union in June 2024. The company is making representations to the authorities. While Europe is a key market comprising a third of revenues in fiscal 2024, direct exports from India are minimal. Moreover, company has sufficient capacity to cater to the region with its plant in Italy albeit at a relatively higher cost of production. Any negative impact on operating performance due to such duty will remain monitorable.

 

Additionally, CRISIL Rating notes the $ 96.5 million jury verdict to Prysmian in a lawsuit against STL’s US subsidiary. The allegations include violation of non-compete agreements and unfair use of trade secrets to further the North America business. The matter is sub judice with STL pursuing legal remedies which will take time to settle. There is no impact on the US operations currently. Any adverse impact on the business and/or financial risk profile including any significant interim liabilities to pursue legal remedies will remain key monitorable.

 

The ratings continue to reflect the dominant market position of STL in the telecommunication (telecom) cables business, its strong order book providing healthy revenue visibility. These strengths are partially offset by large working capital requirement and exposure to intense competition.

Analytical Approach

CRISIL Ratings has combined the business and financial risk profiles of STL and its subsidiaries and joint ventures. STL has significant management control over these entities, which are in the same business and are strategically important to the company.

 

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:

Leading position in Indian optical fibre market and global markets

STL has strong reputation in the optical fibre (OF) and optical fibre cable (OFC) segments in India and abroad, driven by its technically superior products. The company is preferred by OFC manufacturers (for OF) and telecom operators and telecom infrastructure providers (for OFC). Furthermore, it is a one-stop shop for most clients because of its wide system integration and software services offerings. Its global ex-China OFC market share declined to 6% in the fourth quarter of fiscal 2024 compared to 8% for fiscal 2024 due to lower demand in North America market. However, high-quality products, extensive clientele and diversified presence across the broadband infrastructure value chain should help the company sustain strong foothold in the telecom cable industry over the medium term.

 

Healthy capabilities and growth prospects with sizeable order book

STL is among the lowest-cost producers of OF and OFC because of extensive backward integration. Manufacturing OFs from the preform stage offers advantages in terms of cost and quality. The company has plants for power, nitrogen and electrolysis to meet its hydrogen and oxygen requirements. Moreover, it has facilities to produce silicon tetrachloride, the basic raw material for quartz glass manufacturing. With increase in penetration of broadband services, ongoing rollout of 5G services, massive investments towards data centres, focus of the government on rural digitisation, approval of phase 3 of BharatNet project and implementation of Smart City projects and the BEAD programme in North America, the medium-term demand outlook is healthy.

 

Orders of Rs 9,883 crore as on June 30, 2024 provide revenue visibility over the medium term. Of the total orders, ~50% are from the optical networking and digital and technology businesses. This indicates healthy business prospects for STL despite the demerger of its global services business.

 

Weaknesses:

Subdued debt protection metrics and large working capital requirement

Given the slump in operating performance, debt protection metrics were subdued for fiscal 2024. This is despite reduction in net debt to Rs 2,021 crores as on June 30, 2024 post equity-raise of Rs 1000 crore completed in April 2024. Net leverage (net debt to Ebitda ratio) was elevated at around 4.7 times for fiscal 2024 compared to 3.2 times in fiscal 2023 while interest cover deteriorated to 1.7 times for fiscal 2024 compared to 3.2 times in fiscal 2023. Furthermore, interest coverage ratio is likely to remain subdued and net leverage is expected at 3-3.5 times for fiscal 2025. Turnaround in operating performance leading to sustained improvement in financial risk profile going forward will be a key monitorable. Working capital requirement remains elevated due to the high proportion of services business. This leads to stretched receivables since the counterparties are majorly Indian public sector undertakings (PSUs). This is reflected in gross current assets of ~300 days as on March 31, 2024. The working capital cycle will improve significantly once the global services business is carved out from STL.

 

Exposure to intense competition and capex by telcos

The company derives a large part of its revenue from overseas markets and faces intense competition in the international OF and OFC markets. In the domestic market as well, these segments are susceptible to the capex cycles of telecom service providers. Globally, most contracts are finalised through an intensely competitive bidding process, which limits the pricing power of players. However, STL has the largest capacity and is a leading player in the domestic market despite competitive pressure from peers such as Himachal Futuristic Communications Ltd, Vindhya Telelinks Ltd, Aksh Optifibre Ltd and Finolex Cables Ltd.

 

Based on recommendations from the Directorate General of Trade Remedies (DGTR), the Ministry of Finance imposed definitive anti-dumping duty in August 2023 for a period of five years on specific optical fibre imports from China, South Korea and Indonesia. Import data suggests that this move has mitigated the negative impact of low-priced and low-quality imports on domestic players and will continue to benefit them. Similarly, the UK and European Union (EU) have imposed anti-dumping duty on specific OF imports from China, which is benefitting the domestic players that export to the UK and the EU.

Liquidity: Strong

Liquidity will be strong, supported by expected net cash accrual of Rs 400-500 crore per annum over the medium term, cash balance of around Rs 342 crore as on June 30, 2024, and healthy cushion in bank lines. Against this, the company has term debt obligation of around Rs 177 crore in fiscal 2025. Capex of Rs 150-200 crore for fiscal 2025 will be funded largely through internal accrual.

 

Environment, social and governance (ESG) profile

CRISIL Ratings believes the ESG profile of STL supports its already strong credit risk profile.

 

The telecom equipment sector is exposed to material impact on the environment as waste associated with end-of-life network equipment and hardware can pollute land resources. Optical fibres are vital for ensuring uninterrupted telecom services to society and the economy. STL is continuously focused on mitigating its environmental and social impact.

 

Key ESG highlights:

 

• The company is committed to achieve net zero emissions by 2030. Also, by 2030, STL aims to become water-positive across all its manufacturing locations globally. To achieve this target, STL implemented water-recycling models. All its manufacturing plants in Aurangabad are zero liquid discharge certified. Around 1.45 lakh cubic metre of water recycled in the manufacturing process and over 7,500 tonne of carbon dioxide emissions avoided through energy efficiency measures.
• All plants are zero waste to landfill certified.
• The company has started using co-processing in partnership with cement companies as one of the disposal and management solutions, which helps convert waste to energy.
• Female employees constitute 16.7% of the workforce, which is higher than all its peers.
• Its governance structure is characterised by 57% of the board comprising independent directors, split in chairman and CEO positions, healthy investor grievance redressal and extensive disclosures.

 

There is growing importance of ESG among investors and lenders. STL’s commitment to ESG principles will play a key role in enhancing stakeholder confidence, given its moderate share of market borrowings in overall debt and access to both domestic and foreign capital markets.

Rating Sensitivity Factors

Upward Factors

• Significant improvement in operating performance driven by recovery in volumes or realisations, translating into healthy operating margins sustaining above 15-17%.
• Recovery in operating profitability leading to improvement in return on capital employed
• Considerable increase in cash accrual or other deleveraging measures resulting in material improvement in debt protection metrics

 

Downward Factors

• Lower than expected turnaround in scale of operations resulting in inability to improve operating margins sustaining below 10%.
• Continued pressure on operating profitability leading to weak debt protection metrics on sustained basis.
• Adverse impact of ongoing litigations or contingent liabilities on the financial risk profile

About the Company

STL is a leading manufacturer of OFs and OFCs. It has a global presence and manufactures in 4 continents with customers in more than 100 countries. Its offerings include building 5G, Rural, FTTx, Enterprise and Data Centre networks. In 2018, STL acquired Mettalurgica Bresciana, an OFC manufacturer based in Italy.

 

The company reported revenues of Rs 1,218 crore and loss after tax of Rs 48 crore compared to Rs 1,522 crore and Rs 52 crore respectively in the corresponding quarter of the previous fiscal.

Key Financial Indicators (Consolidated)

Particulars	Unit	2024	2023
Revenue	Rs.Crore	5,478	6,950
Profit After Tax (PAT)	Rs.Crore	-51	127
PAT Margin	%	-0.9	1.8
Debt/adjusted networth	Times	1.6	2.2
Interest coverage	Times	1.7	3.2

Note: These are CRISIL Ratings-adjusted numbers

Any other information: Not Applicable