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India Ratings Assigns Varroc Engineering’s CP ‘IND A1’

Feb 06, 2023 | Diversified

India Ratings and Research (Ind-Ra) has rated Varroc Engineering Limited’s (VEL) commercial paper as follows:

Instrument Type Date of Coupon Maturity Size of Issue Rating Rating Action
Issuance Rate Date (million)

Commercial Paper - - 365 days INR1,000 IND A1 Assigned

(CP)*

*CP will be carved out of the fund-based working capital facility.

Analytical Approach: Ind-Ra has taken a consolidated view of VEL and its subsidiaries on account of the strong
operational linkages among them and common management.

Key Rating Drivers

Diversified Revenue Profile: VEL has a well-diversified revenue profile in terms of products. The company’s business units
include polymer, which accounted for around 32% to the total revenues in 1HFY23, electronics (around 23%), lighting
(around 20%), metallic (around 12%), aftermarket (around 9%) and forgings business (3.7%). Post the restructuring of the
company’s operations in FY23, its geographic diversification has moderated with presence now limited to Vietnam,
Romania, Italy, Poland and China, along with a well-spread presence in India.

Established Market Position: VEL is among the leading players in most of its product segments, including 2W lighting,
electronic components as well as digital instrumentation clusters. VEL has strong relationships with 2W original
equipment manufacturers (OEMs) for over three decades. The company is a well-entrenched supplier to Bajaj Auto
Limited and has successfully extended its associations with Hero MotoCorp Ltd., Honda Motorcycles and Scooters India
Pvt Ltd, TVS Motor Company, Yamaha Motor India Pvt. Ltd., and Eicher Motors Ltd. VEL enjoys a dominant wallet-share for
the products it supplies to Bajaj Auto and the management expects the company to gain wallet share in other OEMs as
well, which will help reduce its dependence on Bajaj Auto. Furthermore, the company has 27 manufacturing plants in India
in proximity to the OEMs, which ease the supply chain management.

Divestment of Loss-making Business: VEL, in October 2022, sold its loss-making 4W lighting business in the Americas
and Europe, and the global R&D support team in India, to France-based Compagnie Plastic Omnium Se for an Enterprise
Value of EUR520 million. The divested business had revenues of INR68.9 billion and an EBITDA loss of INR3.13 billion in
FY22, amid the ongoing global chip shortage, Covid-19 pandemic and high fixed-cost requirements.
As a part of the transaction, the net cash accretion to VEL, post-tax was EUR5 million-9 million. Additionally, the company
received EUR28 million in its escrow account, which is to be released over two-to-three years, while EUR33 million of debt
at overseas entity was paid. Consequently, the net debt (excluding acceptances) of the company reduced to around INR13
billion in October 2022 (post divestment; 1HFY23: INR15.7 billion, FY22: INR14.4 billion, FY21 INR22.5 billion). VEL also
had impaired investments of INR13,240 million in these subsidiaries during 1HFY23. While the transaction may not have
added significant cash to the continuing operations, it has benefitted the company on account of the divestment of loss-
making, capex and fixed cost heavy business. The divested business carried a total debt of INR13.8 billion at FYE22 and
hence, would enable the deleveraging of the balance sheet henceforth. The divestment would also reduce VEL’s exposure
to Europe where macro-economic headwinds are more pronounced.

The divestment is part of VEL’s strategy to align its resources with the high-value and high-growth primary markets in India,
China, and the two-wheeler sector globally. The company is now focusing on its operations in India, global 2W lighting
business (Italy, Romania and Vietnam), the Poland & Romania electronics business and the China JV with TYC Brothers
for passenger vehicle lighting products.

Improving Credit Metrics: Post divestment, VEL’s net adjusted leverage (net debt and acceptances/EBITDA), on a
consolidated basis, is likely to improve to 2.6x-2.8x, while improving further to below 2.0x by FY24 (1HFY23: 3.0x, FY22:
4.2x, FY21: 6.8x), as the company exits the debt-heavy overseas business. The company’s reported debt and EBITDA
numbers for FY22 are exclusive of the discontinued operations. Ind-Ra expects the improvement over FY23-FY24, to be led
by margin accretive, cash generative Indian operations, and lower capex requirement in the remaining business. The
interest coverage (EBITDA/interest expense) is also likely to improve to 3.4x-4.5x over FY23-FY24 (1HFY23: 3.4x, FY22:
3.0x, FY21: 3.8x).

VEL’s credit metrics had weakened significantly over FY18-FY20, due to a high capex and losses from its overseas
subsidiaries requiring additional debt to support cash flows.

Improving Profitability Margins: VEL’s reported consolidated EBITDA margin improved to 7.4% in 1HFY23 (FY22: 6.1%,
FY21: 7.7% (adjusted for discontinued operations, pre-adjustment FY21 margins: 3.5%)). Adjusted for one-time forex, the
company’s EBITDA margin grew to 8.4% in 1HFY23 (FY22: 6.3%). The improvement was largely on account of the
divestment of overseas subsidiaries as well as ongoing cost reduction measures, though somewhat offset by commodity
cost inflation. Ind-Ra expects the consolidated EBITDA margins to improve to 8.5%-9% in FY23, as 2HFY23 margins are
likely to benefit from the easing of commodity inflation. The company has been operating at an EBITDA margin of 9%-9.5%
in the Indian operations, which would be contributing to the majority of the revenues and EBITDA henceforth. This will
support EBITDA margin improvement, along with cost rationalisation measures and improving operating leverage. Ind-Ra
expects the EBITDA margin to improve further to 9.3%-9.5% in FY24. Although the company’s margins are prone to any
significant increase in input prices, these can be largely passed on to the OEMs with a lag of three-to-six months. A
sustained improvement in the profitability margins will remain a key rating monitorable.

Liquidity Indicator - Adequate: The company had a cash balance of INR1,920 million as of 1HFY23 (FY22: INR1,178
million). VEL’s average fund based working capital limit utilisation for 12 months ended December 2022 stood less than
40% for India operations and around 55% for VEL standalone. The fund-based limit utilisation is constrained due to the
limited availability of drawing power as the company discounts part of its receivables. Liquidity is also supported by non-
recourse factoring limits of INR5,000 million, which was utilised at an average of 20%-24% during the 12 months ended
December 2022. The Ind-Ra-calculated cash flow from operations (CFO) was positive at INR5,004 million in FY22 (FY21:
INR3,382 million). However, the free cash flow remained negative at INR3,590 million (FY21: negative INR4,369 million), on
account of the higher capex being incurred in the overseas operations. Ind-Ra expects the free cash flow to remain
negative in FY23, while turning positive only in FY24 on account of an improvement in the profitability as well as lower
capex. According to the management, capex outgo is likely to remain limited at INR1,800 million-2,500 million per year in
FY23-FY24, in line with capex for Indian operations in historical years, with a lot of it focused on the EV side. The
divestment of capex heavy overseas operations, would also support free cash generation.
The company has repayments of INR7,153 million in FY23, out of which INR5,050 million of debt held at the overseas
business is already repaid. The company’s debt repayment is also significant in FY24 at INR6,385 million, which includes a
non-convertible debenture bullet repayment of INR3,750 million. The company’s ability to repay or refinance these in a
timely manner would remain a key monitorable.

However, Ind-Ra takes comfort from VEL’s profitable and cash-generative Indian operations, and the company’s ability to
tie up incremental debt (INR6,500 million raised in year-to-date FY23). Ind-Ra expects the liquidity to remain adequate in
2HFY23-FY24, given the positive cash flow generation and an increase in the company’s operations and its improving
capability to service debt obligations.

The net working capital cycle was short at around 10 days in FY22 and around 20 days in 1HFY23 (FY21: around 15 days).
This is partly attributable to the relatively higher creditors. Ind-Ra expects the working capital cycle to remain at similar
levels over the near term, with the better management of creditors as well as receivables.

Improving Product Portfolio Supports Revenue Base: Ind-Ra expects the overall revenue for FY23 to be higher than the
industry’s, with the management bandwidth completely focused on India business, ease of supply side pressures,
improved realisations, and new product introductions. The agency also expects the company to record stable revenue
growth over the medium term, driven by new product introduction and customer additions, as well as an improvement in
the automotive demand scenario. VEL booked a consolidated revenue of INR34,562 million during 1HFY23 and INR58,442
million during FY22 (FY21: INR43,739 million). The increase in the revenue was driven by higher realisations, and
increasing wallet share in 2W OEM players. Ind-Ra expects the revenue to grow at a CAGR of 10.2% over FY22-FY26. In
terms of order book, VEL won new business with lifetime sales of INR35,059 million during FY22 and of INR25,476 million
in 1HFY23, including INR8,676 billion from five EV customers (34% of the new orders received). Lifetime order wins, from
customers excluding Bajaj Auto., has seen a steady increase.

With EV adoption in 2W likely to rise steadily, the company is focussed on making inroads by winning business for
products already developed and technology tailored for EVs. The company’s expertise in designing components for
conventional vehicles has augmented its understanding the complexities of designing components for EVs. For EVs, the
company manufactures traction motor & controller, telematics, and DC-DC converters, including several other products. Of
the new lifetime order book won in 1HFY23, 34% is from EV players.

Segment and Customer Concentration: As a part of restructuring, VEL has divested its 4W lighting business outside India,
thus, increasing the concentration towards 2W & 3W segment. In 1HFY23, the company derived about 68.4% of its
consolidated revenues (FY22: 74%) from the 2W & 3W segment, 27.9% (20.9%) from 4Ws and 3.7% (5%) from others. The
company derives a significant proportion of its revenues from Bajaj Auto (39% to revenues in 1HFY23), though the same
has declined over the previous years. Although the concentration risk from the top five customers remains high
(accounting for around 72% of the total revenues in FY22), Ind-Ra derives comfort from company’s long-established
relationships with the customers.

Standalone profile: On a standalone level, the revenues increased to INR3,2918 million in FY22, a growth of 28.5% yoy and
at a CAGR of around 8.6% over FY19-22 (FY21: INR25,618 million) and the EBITDA margins improved to 9% in 1HFY23
(adjusted to forex gain/loss) from 8.2% in FY22.

Rating Sensitivities

Positive: A positive rating action could result from all of the following events

§ a sustained increase in the revenue and profitability of the company and strengthened revenue diversification

§ an ability to generate strong cash flow margins from the continuing operations, resulting in a better liquidity
profile
 § continuous deleveraging of the balance sheet, leading to the consolidated net adjusted leverage reducing to
less than 2.0x, on a sustained basis

Negative: A negative rating action could result from any of the following events on a consolidated and sustained
basis:

§ the company’s inability to achieve profitability margins in line with the agency's expectations

§ a weakened liquidity position on account of a significant elongation of the working capital cycle or an inability
of the company to refinance/fund any major repayments falling due

§ any large, debt-funded organic or inorganic expansion leading to the consolidated net adjusted leverage
staying above 2.5x

ESG Issues

ESG Factors Minimally Relevant to Rating: Unless otherwise disclosed in this section, the ESG issues are credit
neutral or have only a minimal credit impact on VEL, due to either their nature or the way in which they are being
managed by the entity. For more information on Ind-Ra’s ESG Relevance Disclosures, please click here. For answers
to frequently asked questions regarding ESG Relevance Disclosures and their impact on ratings, please click here.

Company Profile

Incorporated in 1988 in Aurangabad, company designs, manufactures and supplies exterior lighting systems, plastic
and polymer components, electrical-electronic components and precision metallic components to 2W, 3W,
passenger cars, commercial vehicle, and off-highway vehicle (OHV) OEMs in India as well as outside. The company
has end-to-end capabilities across design, R&D, engineering, testing, manufacturing and supply of various products
across business. The Varroc group is promoted by Tarang Jain and his family. VEL is one of the leading 2W
automotive component suppliers in India and a global 2W lighting business and electronics business player that
has a global footprint with 36 manufacturing facilities. VEL sold off its loss making overseas 4W lighting
operations on 6 October 2022.

FINANCIAL SUMMARY - CONSOLIDATED

Particulars FY22 FY21

Revenue (INR million) 58,442 43,739
EBITDA (INR million) 3,676 3,380
EBITDA margin (%) 6.3 7.7
Gross debt (INR million)* 16,717 30,581
Gross interest coverage (x) 3.1 3.8
Net adjusted leverage (x) 4.2 8.7
Source: VEL, IND-Ra
*Including acceptances

Solicitation Disclosures

Additional information is available at www.indiaratings.co.in. The ratings above were solicited by, or on behalf of, the issuer,
and therefore, India Ratings has been compensated for the provision of the ratings.
Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold
any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or
any issuer.

Complexity Level of Instruments

Instrument Type Complexity Indicator

Commercial Paper Low

For details on the complexity level of the instruments, please visit https://www.indiaratings.co.in/complexity-indicators.

Contact

Primary Analyst
Aashi Tayal
Analyst
India Ratings and Research Pvt Ltd
DLF Epitome, Level 16, Building No. 5, Tower B DLF Cyber City, Gurugram Haryana - 122002

For queries, please contact: infogrp@indiaratings.co.in

Secondary Analyst
Ankita Somani
Associate Director

Chairperson
Abhishek Bhattacharya
Senior Director and Head Large Corporates
+91 22 40001786

Media Relation
Ankur Dahiya
Senior Manager – Corporate Communication
+91 22 40356121

APPLICABLE CRITERIA

Corporate Rating Methodology

S h o r t - Te r m R a t i n g s C r i t e r i a f o r N o n - F i n a n c i a l C o r p o ra t e s

Evaluating Corporate Governance

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