Detailed Rationale

CRISIL Ratings has reaffirmed its ‘CRISIL AA-/Stable’ rating on the long-term bank facilities of Happy Forgings Limited (HFL).

 

The rating action reflects the company’s strong business profile supported by its established position in the domestic forged and machined components market, especially in the commercial vehicles (CV) segment, stable working capital cycle while maintaining healthy financial risk profile.  HFL’s scale of operations is expected to increase to over Rs 1400 crore in fiscal 2024 supported by healthy segment and client diversity across the commercial vehicle (CV) and tractor segments, and diversified product offerings, mitigating the impact of demand slowdown in a segment. Revenue grew at a compound annual rate of 16% during the past five years to reach ~Rs 1197 crore in fiscal 2023. Further, diversified product portfolio healthy segmental and customer diversity mitigates the risk of slowdown in any particular segment on the company. Operating margins continue to remain healthy at ~29% in fiscal 23 despite increase in the input prices. This is supported due to the ability to pass on the increase to the OEMs as well reduction in the power expense on account of setting up of solar rooftop plant and increasing proportion of higher-margin machined products. The margins are expected to sustain at 27-29% supported by a change in product mix to heavier products which offer better margins. The financial risk profile is expected to remain healthy, supported by strong cash accruals of over Rs 300 crore which will sufficiently cover debt obligation of Rs 10-15 cr, working capital requirement and capex of ~Rs 170-180 crore in fiscal 2024. The debt metrics are expected to remain comfortable with gearing estimated to improve to 0.16-0.18 time in fiscal 2024.

 

The rating duly factors continuous increase in scale of operations, with a strong customer base in the automotive and industrial segments across geographies, established relationships with OEMs and its technical capabilities. Furthermore, financial risk profile has also improved with interest coverage at 29 times in fiscal 2023 as compared to 22  times in fiscal 2022. Consequently, the net cash accruals have also improved, strengthening the cushion between net cash accruals and repayment obligations supporting the overall liquidity.

 

The company has filed DRHP on August 17, 2023 and is expected to use the proceeds for funding of capex and debt repayment. CRISIL will continue to monitor the development on this. 

 

These strengths are partially offset by working capital-intensive operations, susceptibility to sharp cyclical downturns of commercial vehicle (CV) or tractor segments.

Analytical Approach

CRISIL Ratings has considered the standalone business, financial and management risk profiles of HFL

Key Rating Drivers & Detailed Description

Strengths:

Healthy business risk profile supported by strong relationships with customers

HFL has established track record of more than 3 decades in the manufacturing of forged and machining components  and is the main supplier to several leading domestic OEMs. Over the years, it has added new customers and products to diversify its business profile and clientele. The revival in demand for CVs and tractors has supported the recovery in revenues over past few quarters. HFL is expected to benefit from strong linkages from its existing customers as well as addition of new customers and increased machining proportion which will support the operating margins going forward.

 

Healthy segmental and customer diversity with improving product range

Sales to cyclical sectors like tractors and CV vehicles contributed 41% and 34% of the revenue respectively in fiscal 2023. The balance 25% is derived from passenger cars and utility vehicles, off-highway vehicles, and scrap sales. HFL also has good customer diversity and supplies to leading players in both the tractor and CV segments; it supplies to more than 40 customers with its largest customer accounted for only 15% of revenues in fiscal 2023 and top 5 contributing to around 43%. Exports also increased to 12% in fiscal 2023 compared to 11% in fiscal 2022. With commissioning of newer presses, HFL will further diversify its portfolio to include newer customers as well as increase its share in segments other than MHCV and tractors. HFL has also started diversifying by moving into the non-automobile space like wind, oil& gas, shipping etc.

 

HFL market position benefits from one of the largest players in manufacturing - crankshaft, axle beams segment which can be duly supported by superior growth vis-à-vis industry. The company is in the process of adding new line in the forging with installation of 6300 MT and 10,000 MT press lines which will complete the entire value chain in the forging lines from 2500 MT to 14000 MT press lines. This will support the revenue growth for the company.

 

Strong financial risk profile

Financial risk profile has improved over the years on the back of healthy cash accrual, progressive debt repayment and equity infusion in fiscal 2019. Motilal Oswal Private Equity (MOPE) invested Rs 200 crore in HFL in fiscal 2019, which helped HFL repay debt as well as fund capex. Gearing is estimated to improve to 0.16-0.18 time in fiscal 2024, from 0.2 times as of March, 2023. In fiscal 2024, company is expected to undertake capex of Rs. 150 crore for 10,000 T press line. However, this will be funded through internal accruals.  The financial risk profile is expected to remain healthy, as cash generation will continue to remain strong. The gearing is expected be below 0.2 time and interest coverage ratio is expected to be above 25 times over the medium term.

 

MOPE’s fund, India Business Excellence Fund–III, has 11.76% stake in HFL. The exit to MOPE can be through other routes including sale to another private equity player or through an initial public offering Any material change in this understanding or debt raise by HFL  will be key monitorables.

 

Weakness:

Large working capital requirement: Operations are working capital intensive, as reflected in gross current assets (GCAs) of 149 days as on March 31, 2023. The high GCA days are mainly due to sizeable inventory, given the large product range and high lead time required for manufacturing. Operations will remain working capital intensive due to increasing exports which are more working capital intensive. Also, increasing proportion of exports may keep debtors at elevated level. Debtor days have varied between 109 days to 94 days in the past five fiscals. Prudent management of the same remains a rating sensitivity factor.

 

Susceptibility to cyclicality in the CV and tractor segments: The CV segment is vulnerable to growth in industrial and agricultural production, freight movement, share of road transport in freight movement, changes in freight rates and fuel prices, profitability of truck operators, state transport undertakings and government policies. Also, tractor demand is vulnerable to the vagaries of monsoon and farm income. Capex coinciding with weak demand may pose risk of slower ramp-up of capacities and will remain a key monitorable.

 

Hence, high dependence on these segments poses a risk to revenue and profitability. While HFL has been gradually diversifying its customer base by addition of new clients, revenues and profitability will remain susceptible to segmental concentration, given that HFL derives around 34% from CV segment and 41% from tractor segment. This fiscal, CV demand is expected to remain strong on a recovery while tractor demand is expected to remain moderate due to erratic monsoons.

Liquidity: Strong

Expected cash accrual above Rs 300  crore in fiscal 2024 will sufficiently cover yearly term debt obligation of Rs 15-20 crore over the medium term. Utilisation of fund-based limit was moderate at 36% on average during the last 6 months through May 2023. Steady accrual and unutilised bank lines should be sufficient to meet working capital requirement and debt obligation of Rs 45 cr in fiscal 2024.

Outlook: Stable

CRISIL Ratings believes HFL's business risk profile will benefit over the medium term from the initiatives it has taken to increase share of business from existing domestic and overseas customers, and enhance opportunities in both the markets. Furthermore, improving cash accrual should help sustain the healthy financial risk profile over the medium term despite the ongoing capex cycle.

Rating Sensitivity Factors

Upward factors:

• Increase in scale of operations along with over 1/3rd revenues being generated from new end user industries
• Improvement in financial risk profile due to equity infusion

 

Downward factors:

• Slower-than-expected recovery in performance, most likely due to sluggish business performance resulting in operating margin of below 20%, and cash accruals below Rs.200 crore
• Large debt-funded capex or acquisitions, or buyback or dividend payout, leading to deterioration of debt metrics – gearing sustaining above 1.5 time

About the Company

Established in 1979 by Mr Paritosh Kumar Garg (Chairman cum  Managing Director) and his father, Mr Channan Ram Garg & and further well supported by Mr. Ashish Garg, Managing Director (son of Mr. Paritsoh Kumar Garg), HFL manufactures forged and machined components, primarily crankshafts, for the automotive and non-automotive segments. Facility in Ludhiana has forging capacity of 1,07,000 TPA and machining capacity of 46,000 TPA.

Any other information: Not applicable