Detailed Rationale

CRISIL Ratings has placed its ratings of ‘CRISIL AA-/CRISIL A1+‘ on the bank facilities and debt facilities of Sundaram-Clayton Limited (SCL) on ‘Rating Watch with Developing Implications’.  

 

The rating action follows SCL’s recent intimation to the stock exchanges on February 09, 2022 on the proposal to restructure the existing company into a holding and an operating company respectively, and consolidation of holding companies of the Venu Srinivasan faction of the TVS group.

 

SCL will also demerge its operating assets (aluminium die casting business) which accounts for ~100% of operating revenues into Sundaram Clayton Limited DCD (SCLDCD).  SCLDCD and SCL will have a mirror shareholding and both entities will be simultaneously listed with similar shareholding. Thus, post culmination of this entire transaction, there will be two listed entities, SCL, which will act as a holding company for TVS Motor Company Ltd (TVS Motor), and SCLDCD which will act as an operating company.

 

Further, as per the intimation, SCL proposes to issue bonus Non-Convertible Redeemable Preference Shares (NCRPS) of Rs 10 each at a ratio of 116:1 for each listed equity share of Rs 5 each, totalling ~Rs.2347 crores. The NCRPS will be listed on the exchanges and will be redeemed latest by February 02, 2024 or 12 months from date of issuance, whichever is later. The issuance of these NCRPS will be done from SCL’s reserves and is subject to NCLT approval which expected by next fiscal only.

 

As part of streamlining of holdings held by TVS family members in various TVS group companies, the key promoter family members in fiscal 2021, decided to align the ownership of different group companies with the respective arms of the families managing them. As part of the restructuring, a composite scheme of amalgamation and arrangement is underway, involving T.V. Sundram Iyengar & Sons Ltd. (TVS & Sons), Sundaram Industries Private Ltd. (SIPL) and Southern Roadways Private Ltd. (SRPL) and the family holding companies. The scheme has received approval from the National Company Law Tribunal (NCLT) and is being implemented. As a part of the scheme, TVS Holding Pvt Ltd (THPL) has acquired the shareholdings of TVS & Sons, SIPL and SRPL and consequently as on date holds ~64.72% in SCL. Another holding company of the Venu Srinivasan family - VS Investment Pvt Ltd (VSIPL) has also raised ~Rs 1600 crore of loans which ultimately will be used to facilitate the entire rearrangement of shares. Ultimately, under the recent announcement, THPL and VSIPL will be merged with SCL and thereby NCRPS issued to THPL will be extinguished against the loan of Rs.1600 crore. 

 

SCL will utilise part proceeds realised on sale of shares of TVS Motor for redemption of balance NCRPS (issued to public shareholders and other promoter entities).  While most operating companies of the TVS group are not directly part of the family agreement, their holdings will witness a change, as the intent of the scheme is to also simplify the shareholding structure and give control to family factions managing them. SCLDCD, SCL and its leading subsidiary, TVS Motor, and current subsidiaries under these companies, will remain within the Venu Srinivasan faction of the TVS group.

 

CRISIL Ratings will closely monitor the outcome of this proposed rearrangement scheme,  issuance of NCRPS,  and will remain in dialogue with the management of SCL. The ratings will be removed from watch and final rating action taken once necessary approvals are in place, and more details are made available on the restructuring scheme, resultant financial position of the entities, as well as stance of support from promoters to the operating entities.

 

On the operational front, SCL faced some headwinds due to the second wave of covid-19 in the first quarter which resulted in localised lockdowns and preponing of maintenance shutdowns by domestic original equipment manufacturers (OEMs). The company’s operating performance has recovered from the second quarter, mainly driven by pick-up in certain domestic OEM segments barring two-wheelers, as well as strong export demand. Backed by higher realisations in keeping with higher aluminium prices, SCL’s revenues are likely to register a healthy growth of 12-14% in fiscal 2022, while better operating leverage and continuation of past cost rationalisation measures will ensure operating margins sustain at ~13-14% (similar to fiscal 2021). Some moderation in revenue growth to 9-11% is likely in fiscal 2023, as aluminium prices, which are a pass through, are likely to see some decline after a sharp increase in the past two fiscals. Operating profitability is expected to stabilise at 12-14% next fiscal, leading to steady operating profits.

 

SCL’s financial risk profile is supported by its healthy net worth (~Rs. 2250 crores at September 30, 2021), and adequate debt metrics. Steady dividend flow from its 52% subsidiary, TVS Motor Co. Ltd (TVS Motor) supports is net profits. With nominal capital spending undertaken since fiscal 2020 and supported by steady accruals, its gearing improved to 0.88 times at March 31, 2021 from 1.06 times at March 31, 2019. SCL is expected to avail debt up to Rs 200 crore in the near term, partly as reimbursement of investment done in its US based step-down subsidiary, Sundaram Holding USA Inc (SHUI, which in fiscal 2021 was 32% held by SCL and 68% by Sundaram Auto Components Ltd (SACL), a wholly owned subsidiary of TVS Motor) and also for further investments in SHUI, as well as to support its debt obligations. The additional debt being raised will not materially impact SCL’s debt metrics, due to the sizeable profits of `Rs.1500 crore generated on sale of ~5% stake in TVS Motor in the first half of fiscal 2021. The said proceeds are likely to be utilised for redemption of NCRPS and for repayment of loan post completion of the restructuring exercise. In the interim, strong re-financing capabilities arising from SCL’s 52% stake in TVS Motor (market value of over Rs 16,000 crore as on February 15, 2022) continues to drive its financial flexibility.

 

The ratings continue to reflect SCL’s diverse customer base across automobile sub-segments and geographies, above average operating efficiency, and adequate financial risk profile. The ratings are also supported by SCL’s sizeable investment in TVS Motor, which also enhances its financial flexibility. These strengths are partially offset by high revenue dependence on the cyclical commercial vehicle (CV) segment, and on OEMs, which limits pricing power; and exposure to increasing competition.

Analytical Approach

For arriving at its rating, CRISIL Ratings has considered SCL’s standalone business and financial risk profile. Its largest subsidiary, TVS Motor has not been consolidated as it is a strong cash generating entity, and no support from SCL is envisaged. SHUI is majorly held by SACL, and no guarantee has been provided by SCL for SHUI’s debt. Hence, SHUI has not been consolidated with SCL, though need based support has been considered. Other financial subsidiaries have also not been consolidated, as they are in different lines of businesses, though need based investments which may be required have been factored.

Key Rating Drivers & Detailed Description

Strengths:

Diverse customer base, spread across automotive sub-segments and geographies

SCL’s customer base is diverse, spread across sub-segments of the auto sector, such as two-wheelers, passenger cars, and CVs, and across geographies. Healthy demand growth from two-wheeler and domestic CV segment in fiscal 2018, and for most of fiscal 2019, enabled good growth in domestic volumes for SCL, besides offsetting impact of sluggish demand from passenger vehicle OEMs. Albeit moderation in aluminium prices in the recent past (which is a pass through) impacted realisations. Higher aluminium prices have supported revenues since fiscal 2021. The company has enhanced its production capacity, including for passenger OEM customers, which has enabled it to increase market share during the recovery in fiscal 2021, and benefit of same is continuing in fiscal 2022 also.

 

Healthy share of exports also enhances SCL’s revenue and geographic diversity. While the company’s share of export revenue declined to 35-37% in fiscals 2017 and 2018, from over 40% in fiscal 2016 due to sluggish demand from European customers, better demand from US markets helped exports recover to over 45% of revenues in fiscal 2021 and share of exports is expected to remain over 40-45% in the near to medium term.

 

Presence across sub-segments and geographies, partially offsets the impact of cyclicality inherent in the business. The diverse customer base and increased demand from export as well as domestic customers, and increased contribution from recently expanded capacities should support revenue growth over the medium term.

 

Above average operating efficiencies

Operating profitability has been largely stable at 10-13% since fiscal 2014 (except a temporary blip in fiscal 2018), backed by ability to pass on changes in raw material prices onto end customers. Implementation of industry-wide best practices, such as Total Quality Management, enterprise resource planning and other internal automation measures, help products meet the rigorous standards of the top global auto manufacturers. Despite limited technological collaboration, SCL has maintained steady business with most customers, on the back of its adequate operating capabilities. During fiscal 2020, SCL has implemented proactive cost optimization measures in low cost automations, employee consolidation, recycling of materials etc. which has facilitated better cost management during the downturn and weather the impact of pandemic related disruptions. Benefits of these has started to accrue as operating margins are being maintained at over 13% over the last few quarters and are expected to continue at 12-14%.

 

Adequate financial risk profile and healthy financial flexibility

SCL’s financial risk profile is supported by healthy net worth (~Rs 2250 crore at September 30, 2021), and adequate debt protection metrics. SCL had undertaken large capital expenditure amounting to ~Rs 400 crore in fiscals 2018 and 2019 which was partly funded through debt. This in turn led to moderation in gearing to 1.06 times as of March 31, 2019. However, with completion of the large capex in fiscal 2019 and only nominal capital spends over the next two fiscals, gearing reduced to 0.88 time at March 31, 2021. In the first quarter of fiscal 2022, SCL sold 5% stake in TVS Motor for Rs 1495 crore.

 

The company’s capex spend is expected at Rs. 50-60 crore over the next two fiscals, mainly for routine modernisation, with sufficient headroom available in existing capacity. As of fiscal 2021, SCL had invested Rs.155 crore in SHUI (32% stake) and is expected to avail debt of Rs 200 crore over the near to medium term, partly as reimbursement of investments done in SHUI and also for further investments in operations and meeting debt obligations. SHUI, which is into similar business as SCL, had negligible operations during fiscal 2021, and the initial period of current fiscal due to pandemic related disruptions in the US market. However, operations have commenced in the second half of fiscal 2022 and are being ramped-up. The company is expected to break even in fiscal 2023, and SCL is expected to support SHUI in the interim by infusing moderate equity to meet debt repayments, and other investments. However, SACL is expected to continue being the major shareholder of SHUI, and no guarantee is likely to be provided by SCL for debt raised by SHUI. Any change to this effect, will be a rating monitorable.

 

The additional debt being raised will not materially impact SCL’s gearing as its net worth has materially improved due to the sale stake in TVS Motor. Other debt protection metrics like interest cover should also sustain at over 4-5 times over the medium term.

 

With the plan of demerger being announced, the stake in TVS Motors is expected to be retained in the holding company while SCLDCD will be holding the operating assets. Nonetheless, due to common promoters and holding structures, CRISIL expects both companies to benefit from the holding in TVS Motor. CRISIL Ratings believes SCL is unlikely to dilute its stake in TVS Motor below 50% in the medium term and in the interim, the market value of the stake will continue to underpin SCL’s financial flexibility, in addition to providing steady dividend income. Any significant dilution in stake in TVS Motor or material decline in market value of holding, will remain a rating monitorable.  

 

Weaknesses

Significant exposure to cyclical CV segment:

SCL has a high exposure to the CV segment given that it almost derives its entire export revenues from the CV segment, although the domestic customer base is spread across automotive industry sub-segments. Any cut in production schedules by key CV customers could result in a decline in capacity utilisation, and return on capital employed (RoCE), especially with specific lines being devoted to key customers.

 

While SCL has enhanced its production capacity and hence will be able to manage sudden surge in offtake by customers over the medium term, it remains vulnerable to cyclical offtake mainly by the CV segment, which could affect both revenue and profitability.

 

Susceptibility to pricing pressure from OEMs

SCL is highly dependent on offtake by Tier-I auto component suppliers as well as OEMs, in both the domestic and export markets. High exposure to OEMs exposes the company to significant pricing pressure. While SCL is able to pass on key raw materials costs to its customers, it has limited flexibility in passing on increase in conversion costs like power costs, employee costs etc., although the continuous cost control measures and process improvements over the years have partly mitigated the impact.

Liquidity: Strong

Liquidity is strong largely supported by steady cash accrual (estimated annually at over Rs. 135-140 crore) and adequate headroom in bank lines (average utilization of about 20% on sanctioned bank limits of Rs 861 crore over the last 6 months ended November 2021). Besides, the company has the flexibility to monetise part stake in TVS Motor in the event of exigencies. As of February 15, 2022, SCL held 52% stake in TVS Motor (market value of ~Rs 16,000 crore) substantially enhancing financial flexibility. Earlier this fiscal, SCL sold 5% stake in TVS Motors for Rs 1495 crore.

 

The company has debt obligations of Rs. 128 crore in fiscal 2022 and Rs. 107 Crore in fiscal 2023, which are expected to be partly refinanced. Capex spending is expected to be moderate over the medium term, due to sufficient headroom in capacity.

Rating Sensitivity factors

Upward factors:

• Better than anticipated revenue growth, driven by increased presence in both domestic and overseas markets, and sustenance of operating profitability (12-14%), leading to healthy cash generation.
• Prudent capital spending and working capital management, supported by healthy cash generation, leading to better debt metrics
• Sizeable increase in market value of holdings in TVS Motor, further enhancing financial flexibility

 

Downward factors:

• Deterioration in revenues by over 10-15% owing to  slowdown in demand from domestic and export markets, and decline in operating margins to less than 6-8%, impacting cash generation
• Large debt funded capex or acquisition or significant stretch in working capital levels impacting debt metrics
• Further restructuring within the group, leading to consolidation of SHUI, also impacting debt metrics
• Material reduction in financial flexibility and change in stance of support post transfer of TVS Motor stake to SCL (holding company)

About the Company

SCL was incorporated in Chennai in 1962 and is part of the TVS group led by Mr. Venu Srinivasan. The company is a leading manufacturer of aluminium die-casting components. It supplies to major automotive OEMs including TVS Motor, the Cummins group, the Volvo group, Hyundai Motor India Ltd (rated ‘CRISIL AAA/Stable/CRISIL A1+’), Ford Motors, the Daimler group, and to component suppliers such as Wabco India Ltd and the Visteon group. SCL was set up by the TVS group and the UK-based Clayton Dewandre Holdings Ltd.  

 

Until fiscal 2007, SCL’s financials included the CV brakes business. With effect from March 28, 2008, the Madras High Court approved the de-merger of the brakes business into a separate company, Wabco India Ltd. The non-brakes business (aluminium die-casting) and investments in the TVS group entities remained with SCL. The company has its main die-casting component production facilities at Padi, Mahindra City, and Oragadam in Chennai, and Belagondapalli at Hosur, in Tamil Nadu. During fiscal 2012, SCL restructured its businesses, hiving off the non-automotive businesses into its erstwhile subsidiary, Sundaram Investments Ltd (SIL).

 

For the 9 months of fiscal 2022, SCL’s profit after tax (PAT) was Rs. 1554 crore on net sales of Rs. 1246 crore, against losses of Rs. 7 crore on net sales of Rs. 772 crore for the corresponding period of previous fiscal. The increase in PAT is mainly due to extraordinary income by way of the stake sale in TVS Motor during this period.

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 Level	Rating Assigned with Outlook
INE105A08014	Non Convertible Debenture	18-Aug-20	7.65%	18-Aug-25	100	Simple	CRISIL AA-/Watch Developing
NA	Bank Guarantee	NA	NA	NA	6	NA	CRISIL A1+/Watch Developing
NA	Cash Credit#	NA	NA	NA	210	NA	CRISIL AA-/Watch Developing
NA	External Commercial Borrowings	NA	NA	Feb-24	172.56	NA	CRISIL AA-/Watch Developing
NA	FCNR (B) Long Term Loan	NA	NA	Sep-22	218.52	NA	CRISIL AA-/Watch Developing
NA	Letter of Credit	NA	NA	NA	75	NA	CRISIL A1+/Watch Developing
NA	Rupee Term Loan	NA	NA	Dec-22	100	NA	CRISIL AA-/Watch Developing
NA	Rupee Term Loan	NA	NA	Dec-27	200	NA	CRISIL AA-/Watch Developing
NA	Commercial Paper	NA	NA	7-365 days	100	Simple	CRISIL A1+/Watch Developing

# Interchangeable with packing credit in foreign currency (PCFC)/Bills Discounting/Short Term Loans