Detailed Rationale

CRISIL Ratings has assigned its ‘CRISIL A1+’ rating to Rs.2347 crore Cumulative Non-Convertible Redeemable Preference Shares of Sundaram-Clayton Limited (SCL).

 

CRISIL Ratings has also removed its ratings on the bank facilities, non convertible debentures and commercial paper of SCL from ‘Rating Watch with Developing Implications’ and has reaffirmed the ratings at ‘CRISIL AA-/CRISIL A1+’, while assigning a ‘Stable’ outlook to the long term rating. The existing ratings were earlier on ‘Rating Watch with Developing Implications’

 

The revision in rating for existing facilities, follows National Company Law Tribunal (NCLT) approval on the composite scheme of arrangement on March 6, 2023, following which the aluminium die-casting business (manufacturing operations) in SCL and its subsidiairies, will be demerged into a separate entity, Sundaram Clayton DCD Ltd (SCDCD). The entire process of demerger of manufacturing operations  is expected to be completed by June 2023.  

 

The ratings assigned on the cumulative NCRPS factors CRISIL Ratings expectations that, SCL will maintain a healthy credit profile and debt cover, post the ongoing scheme of restructuring and arrangement, which has been approved by the NCLT, following which SCL (excluding its manufacturing operations), will ultimately become mainly a holding company, with 50.26% stake in TVS Motor Company Ltd (TVSM). Once the process of restructuring is completed (expected in short term), the market value of SCL’s stake in TVSM (currently in excess of Rs.26,000 crore), and only moderate debt mainlly in form of NCRPS will ensure healthy debt cover.

 

As per the scheme of arrangement approved by the NCLT, the first step would involve SCL  undertaking a bonus issue of NCRPS of Rs 10 each at a ratio of 116:1 for each listed equity share of Rs 5 each of SCL, totaling Rs.2347 crores. The NCRPS will be listed on the exchanges and will be redeemed no later than 12 months from date of issuance. The issuance of these NCRPS will be done from SCL’s reserves.

 

The second stage would be amalgamation of TVS Holdings Private Limited (THPL) which holds 64.72% stake in SCL with SCL. Upon amalgamation, the promoter family members will become direct shareholders of SCL and will also receive cumulative NCRPS equivalent to their shareholding worth Rs.1520 crores. The promoters will transfer the cumulative NCRPS to another promoter entity, Venu Srinivasan Investments Private Limited (VSIPL) to repay the loan taken from the entity from lenders, which has been on lent to promoters, who have used the proceeds for settlement among TVS family members, as part of the TVS family arrangement executed in December 2021. Following the family arrangement among TVS family, all cross-holdings of stake of SCL now vest with investment companies held by Mr Venu Srinivasan and his family members.

 

Subsequently in the third stage, VSIPL will amalgamate with SCL, thereby extinguishing the reserves and cumulative NCRPS on the books of VSIPL and the loan outstanding will be repaid with cash balance available in SCL (Rs.2050 crores as on September 30,2022) to an extent of Rs.1520 crore.  Any residual loans will be cleared by the promoters. It may be noted that, SCL had diluted about ~7% stake in TVSM for consideration of ~Rs.2100 crores in the open market in fiscal 2022. Further, SCL had also sold off its stake in Suprajit Engineering Ltd for a consideration of ~Rs.150 crores in fiscal 2022.

 

The final stage will be the demerger of SCL’s existing die-casting business (manufacturing operations) into SCLDCD. Both SCL and will have  mirror shareholding and both entities will be listed. Thus, post culmination of this entire transaction, there will be two listed entities, SCL, which will act as a holding company for TVSM, and SCLDCD which will act as an operating company, carrying out manufacture of die-casting components.

 

The management of SCL has indicated that the assets and liabilities presently on the books of SCL which are related to manufacturing operations will be moved to SCLDCD. Therefore, in terms of debt remaining, SCL will have cumulative NCRPS (owed to other promoter entities and public shareholders of Rs.828 crores) as debt which will be redeemed within 12 months from the date of issuance.

 

Subsequently, the resulting SCL will be renamed as TVS Holdings Limited and SCL DCD will be renamed as SCL.

 

In September 2022, SCL had acquired 50.05% stake in Sundaram Holdings USA Inc (SHUI), holding entity of Sundaram-Clayton USA Limited (SCUL), from Sundaram Auto Components Limited (SACL), a wholly owned subsidiary of TVSM for a consideration of Rs.317 crores. Prior to this transation, SCL already held 49.95% stake in SHUI; thereby post the transaction, SHUI became a 100% subsidiary of SCL. The consideration was funded through liquid surplus generated from the stake sale in TVSM.

 

On the operational front, in the first nine months of fiscal 2023, SCL’s manufacturing revenues grew by 25% driven by healthy domestic demand in all segments and stable export demand, as well as higher realizations in keeping up increased aluminium prices. Better operating leverage, pass through of input price increases and continuation of past cost rationalization measures have helped SCL to sustain the operating margins at ~11.5-12%. For the full year, SCL’s revenues are expected to register 18-20% revenue growth driven partly by incremental revenue contribution from SHUI as well. However, its consolidated operating margins are expected to be below 10% due to operational losses in SHUI. Over the medium term, the revenue growth is expected to be at 5-7% driven by healthy domestic volumes and almost stable export demand. Operating profitability is expected to gradually improve to 12-14% in fiscal 2024, also supported by turnaround in operaions at SHUI. In the interim, SCLDCD’s debt metrics will remain adequate, despite moderating temporarily due to losses at SHUI, as well as debt relating to SCUI. For instance, SCLDCD’s gearing is estimated to range between 1.1-1.2 times at March 31, 2023, while the ratio of debt to earnings before interest, depreciation, tax and amortization (EBITDA) is expected at ~5 times in fiscal 2023. These ratios are excpected to witness gradual improvement from fiscal 2024 onwards.

 

The ratings continue to reflect SCL DCD’s diverse customer base across automobile sub-segments and geographies, above average operating efficiency, and adequate financial risk profile. 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. Loss making operations of SHUI are also a limiting factor.

 

SCL (holding company) enjoys healthy debt cover, relative to value of its shareholding in TVSM, which also enjoys a healthy credit profile. That said, the holding company also remains exposed to market-related risks and part reliance on dividend inflows from TVSM for debt-servicing.

Analytical Approach

CRISIL Ratings has used the holding company approach to arrive at rating of SCL (which will become the holding entity) for purpose of rating the cumulative NCRPS. SCL post completion of transaction will hold ~50.26% is TVSM. Its other businesses, which will be modest, will include management services for the group, and trading in automobile components. TVS Holdings Private Limited (THPL), and Venu Srinivasan Investments Private Limited (VSIPL), have been consolidated with SCL (holding company), as these entities are in process of getting amalgamated with SCL.

 

For arriving at the existing rating of the debt facilities of the die-casting business which will be housed under SCLDCD, CRISIL Ratings has considered the consolidated die-casting business of SCLDCD and SHUI. SCLDCD is also expected to provide managerial, organizational, and financial support to SHUI, which is in similar line of business. Prior to the acquisition of majority stake in SHUI in September 2022, CRISIL Ratings has considered standalone credit profile of SCL to arrive at the rating.

 

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:

Diverse customer base, spread across automotive sub-segments and geographies: SCL’s die casting business customer base is diverse, spread across sub-segments of the auto sector, such as two-wheelers, passenger cars, and commercial vehicles (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 SCLDCD, 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 realizations. 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 since fiscal 2022.

 

Healthy share of exports also enhances SCLDCD’s revenue nd 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 at ~ 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, SCLDCD has maintained steady business with most customers, on the back of its adequate operating capabilities. During fiscal 2020, SCLDCD 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 two fiscals. While operating profitability is expected to dip to below 10% in fiscal 2023 due to consolidation with SHUI, the same are expected to recover to  ~12-14% over the medium term with improvement in SHUI’s performance.

 

Adequate financial risk profile and healthy financial flexibility: The die-casting business’s resultant financial risk profile is likely to moderate temporarily with increase in debt due to consolidation with SHUI. The gearing is expected to be slightly higher than 1 time post demerger and Debt/EBITDA is expected to rise temporarily to ~5 times in fiscal 2023 post demerger. Among the present cash balance of over Rs.2000 crores, some part will be retained in by the die-casting business being demerged. However, the overall credit profile of demerged SCLDCD will not vary materially from credit profile of resulting SCL, the holding entity.

 

SCLDCD’s  capex spend is expected at Rs. 100-120  crore over the next two fiscals, mainly for routine modernisation and maintenance, with sufficient headroom available in existing capacity. With improvement in performance of SHUI, the debt metrics will improve from fiscal 2024 onwards., However, in the interim, any support required to meet the debt obligations in SHUI and operational losses will be provided by the domestic die-casting business’ operational cash flows, or by additional debt.

 

With the planned demerger, the stake in TVSM is expected to be retained in the holding company while SCLDCD will be holding the manufacturing assets. Nonetheless, due to common promoters and holding structures, CRISIL Ratings expects both companies to benefit from the holding in TVSM.  CRISIL Ratings believes SCL(the resulting holding company) is unlikely to dilute its stake materially in TVSM 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 TVSM or material decline in market value of holding, will remain a rating monitorable. 

 

Healthy cover available for the holding company: SCL, the resulting holding company, will hold 50.26% stake in TVSM which is valued at over Rs.26000 crores (as at March 10, 2023). SCL’s debt profile will mainly comprise cumulative NCRPS worth Rs.828 crores due for redemption in 12 months from the date of issuance and coupon payment of 9% p.a totaling the liability to Rs.903 crores. The high market capitalization provides healthy debt cover of over 30x at present and support the credit profile of SCL.

 

The liabilities of Rs.903 crores due in 1 year will be serviced by mix of cash available post demerger (estimated to be over Rs.350 crores), dividend income from TVSM, and income generated from trading operations, royalty and management services income. If required, SCL will also have the flexibility to refinance any shortfall due to the healthy cover available and healthy relationship with bankers.

 

Healthy credit risk profile of TVSM: TVSM is India's fourth-largest two-wheeler (including mopeds) manufacturer and second-largest exporter of motorcycles. It will continue to benefit from its strong market position and proposed launches in different two-wheeler segments. TVSM’s two-wheeler (motorcycles and scooters) volumes grew by 15% in fiscal 2022, despite decline in industry volumes by 2%. Its marketshare in the domestic motorcycles market improved improved to 9 months in the first 11 months of fiscal 2023 (8% in fiscal 2022), compared to 6% in fiscal 2021. Similarly, its domestic markt share Iin scooter segment improved to 24% in the first 11 months of ficsal 2023 Meanwhile, domestic market share of scooter segment improved to ~24% in the first 11 months of fiscal 2023 (22% in fiscal 2022), compared with ~21% in fiscal 2021. The increase in market share was driven by the company’s brand relaunches, as well as existing models.

 

TVSM’s business risk profile also benefits from the technological tie-up with BMW Motorrad for manufacturing two wheelers and expansion in export markets (Central America and Sri Lanka). The company is also entering the EV space with substantial investments expected over the next 3-4 years for manufacturing vehicles across categories.

 

The acquisition of the British motorcycle brand ‘Norton’ and associated assets from Norton Motorcycles Holdings Ltd and Norton Motorcycles (UK) Ltd amongst others, will help TVSM diversify its offerings in the premium segment in European and Indian markets. Albeit volumes are not expected to be meaningful in the near term, with Norton requiring support to stabilise and turnaround its operations atleast for next couple of years.

 

Operating profitability is expected to continue to improve as regular price hikes and benefits of past cost cutting measures has helped partially offset the impact of rising commodity prices. Moreover, operations at the Indonesian subsidiary have also been improving with company booking profits since fiscal 2021.  

 

TVSM’s financial risk profile also remains healthy, due to strong cash generation, resulting in good  debt metrics as well. The company’s interest cover stood at 11.6 times in fiscal 2022 (9.3 times in fiscal 2021) These are expected to be sustained, due to prudently funded expansion plans.

 

Weaknesses:

Significant exposure to cyclical CV segment: The die-casting business has 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 higher capacity, the die-casting business will be able to manage sudden surge in offtake by customers over the medium term. That said, it remains vulnerable to cyclical offtake mainly by the CV segment, which could affect both revenue and profitability.

 

Susceptibility to pricing pressure from OEMs: The die-casting business 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 SCLDCD 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.

 

Higher than anticipated losses in USA Subsidiary, SHUI: SHUI initially was setup as subsidiary of SACL, a wholly owned subsidiary of TVSM with SACL holding 56% and SCL holding 44%. SHUI is primarily involved in die casting business in Delaware, USA, and began operations from fiscal 2021. Over the years, SCL increased its stake to 49%, and then also bought out 51% stake in SHUI from SACL, following which SHUI became the wholly owned subsidiary of SCL.

 

SHUI has been making operational losses for the past 3 fiscals. The ramp up was delayed due to covid-19 and subsequent moderation in demand from OEMs. While losses were expected to decline materially in fiscal 2023 and the company was expected to turnaround, SHUI is expected to report losses of Rs.80-100 crore at operational level. The ramp up in operations and breakeven at operational level is expected in the next fiscal, linked to demand from US based OEMs. Timely ramp up of revenue levels, and turnaround of operations will remain a monitorable.

 

Exposure to market-related risks and part reliance on dividend inflows for debt-servicing: For SCL (holding company), the exposure to market-related risks may persist, as financial flexibility, in terms of cover available, will, to some extent, depend on prevailing market sentiments and share price of TVSM. Any increase in systemic risks, leading to a sharp fall in the share prices of TVSM, or larger than expected debt levels at SCL (holding company) will be key rating sensitivity factors. Furthermore, part of servicing of NCRPS will remain dependent on dividend inflows from TVSM.

Liquidity: Strong

Liquidity is strong for SCLDCD largely supported by steady cash accrual (estimated annually at over Rs. 135-140 crore) and adequate headroom in bank lines (Rs.861 crores of sanctioned limits).  Even though the flexibility due to stake held in TVSM will not be available directly post demerger, the flexibility will arise from the promoter level who will retain the ability to support its businesses if required. Capex spending is expected to be moderate over the medium term, due to sufficient headroom in capacity. Repayment obligations are Rs.137 crore in fiscal 2023 and Rs. 160-165 crore in fiscal 2024 on a consolidated basis, which can be serviced from annual accruals and will partly be refinanced.

 

Liquidity for resulting SCL (holding company) will be driven largely by market value of its stake in TVSM, which is estimated at over Rs.26000 crores as of March 10, 2023. Besides, it will also be supported by healthy dividend income of Rs.80-90 crores per annum, royalty income and management services income. The cumulative NCRPS will be repayable at the end of 12 months from date of issuance and including the dividend will amount to Rs.903 crores. The same is expected to be paid out from cash surpluses, dividend income, and partly through refinancing, if required.

 

Rating sensitivity factors – Cumulative NCRPS

• Material decline in the market value of investments in TVSM on a sustained basis, or higher than expected debt levels, impacting financial flexibility, as well as debt cover (for instance below 8-10 times).
• Significant decline in the credit profile of TVSM

Outlook: Stable (for existing debt facilities relative to SCLDCD)

CRISIL Ratings expects SCL will continue to witness steady improvement in its business performance, supported by healthy off-take especially from domestic automotive original equipment manufacturers for its die-cast components, adequate operating efficiencies, and turnaround of its US operations from next fiscal. Besides, its financial risk profile, will also gradually improve over the medium term, after undergoing temporary moderation in fiscal 2023.

Rating Sensitivity factors – SCLDCD

Upward factors:

• Sustained steady annual revenue growth driven by increased market share in both domestic and overseas markets, and operating profitability of over 13-14%, leading to healthy cash generation.
• Prudent capital spending and working capital management, which along with routine debt repayment will support improvement in key debt metrics

 

Downward factors:

• Sharp decline in revenues, owing to  slowdown in demand from domestic and export markets, or due to delay in ramp up of operations in US subsidiary leading to decline in operating margins to less than 8-9%
• Large debt funded capex or acquisition or significant stretch in working capital levels further impacting debt metrics
• Change in stance of support post movement of stake in TVSM to SCL (holding company),

About the Company

SCL was incorporated in Chennai in 1962. 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 first nine months of fiscal 2023, SCL’s profit after tax (PAT) was Rs. 111 crore on net sales of Rs. 1563 crore, against profit after tax (PAT) of Rs. 1554  crore on net sales of Rs.1246  crore for the corresponding period of previous fiscal. The higher PAT in the first nine months of previous fiscal was mainly due to extraordinary income by way of the stake sale in TVSM during that period.

Any other information: Not applicable

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-2020	7.65%	18-Aug-25	100	Simple	CRISIL AA-/Stable
NA	Bank Guarantee	NA	NA	NA	6	NA	CRISIL A1+
NA	Cash Credit#	NA	NA	NA	210	NA	CRISIL AA-/Stable
NA	External Commercial Borrowings	NA	NA	Feb-2024	106.76	NA	CRISIL AA-/Stable
NA	FCNR (B) Long Term Loan	NA	NA	Dec-2027	140	NA	CRISIL AA-/Stable
NA	Letter of Credit	NA	NA	NA	75	NA	CRISIL A1+
NA	Commercial Paper	NA	NA	7-365 days	100	Simple	CRISIL A1+
NA	Rupee Term Loan	NA	NA	Sep-2027	185.5	NA	CRISIL AA-/Stable
NA	Proposed Long Term Bank Loan Facility	NA	NA	NA	258.82	NA	CRISIL AA-/Stable
NA	Cumulative Non-Convertible Redeemable Preference Shares^	NA	NA	NA	2347	Complex	CRISIL A1+