ISGEC Hitachi Zosen Limited: Ratings Reaffirmed for Enhanced Bank Lines; Assigned for Term Loans

(Revised) March 17, 2020

ISGEC Hitachi Zosen Limited: Ratings reaffirmed for enhanced bank lines; assigned for term loans

Summary of rating action Previous Rated Amount Current Rated Amount Instrument* Rating Action (Rs. crore) (Rs. crore) Fund-based 140.0 130.0 [ICRA]AA(CE) (Stable); reaffirmed Fund-based 10.0 10.0 [ICRA]AA-(CE) (Stable); reaffirmed Non-fund based 320.0 355.0 [ICRA]AA(CE) (Stable); reaffirmed Non-fund based 25.0 25.0 [ICRA]BBB+ (Stable); reaffirmed Non-fund based 20.0 20.0 [ICRA]AA-(CE) (Stable); reaffirmed Term loans - 20.0 [ICRA]BBB+ (Stable); assigned Unallocated limits 35.0 10.0 [ICRA]BBB+ (Stable); reaffirmed Total 550.0 570.0 *Instrument details are provided in Annexure-1

Rating Without Explicit Credit [ICRA]BBB+ Enhancement

Note: The (CE) suffix mentioned alongside the rating symbol indicates that the rated instrument/facility is backed by some form of explicit credit enhancement. Earlier, the rating symbol for this instrument/facility used to be accompanied by the (SO) suffix. The change in suffix is not to be construed as a change in rating. This rating is specific to the rated instrument/facility, its terms and its structure and does not represent ICRA’s opinion on the general credit quality of the entity concerned. The last row in the table above also captures ICRA’s opinion on the rating without factoring in the explicit credit enhancement

Rationale For the [ICRA]AA(CE)(Stable) rating The above rating is based on the strength of the corporate guarantee provided by ISGEC Heavy Engineering Limited (IHEL)1, holding 51% stake in ISGEC Hitachi Zosen Limited (IHZL), for the rated bank lines. The Stable outlook reflects ICRA’s outlook on the rating of the guarantor, IHEL.

Adequacy of credit enhancement For assigning the rating, ICRA has assessed the attributes of the guarantee issued by IHEL in favour of the said bank facilities. While the guarantee is legally enforceable, irrevocable, unconditional, covers the entire amount and tenor of the rated facilities, it lacks a well- defined invocation and payment mechanism. Nevertheless, the guarantee provided by IHEL is adequately strong to result in an enhancement in the rating of the said facilities to [ICRA]AA(CE) against the rating of [ICRA]BBB+ without explicit credit enhancement. In case the rating of the guarantor were to undergo a change in future, the same would reflect in the rating of the aforesaid facilities as well. The rating of these facilities may also undergo a change in a scenario whereby, in ICRA’s assessment, there is a change in the strength of the business linkages between the guarantor and the rated entity or there is a change in the reputation sensitivity of the guarantor to a default by the rated entity or there is a change in the strategic importance of the rated entity for the guarantor.

Salient covenants related to the credit enhancement, as specified in the guaranteed documents

1 rated [ICRA]AA(Stable)/[ICRA]A1+.

For the [ICRA]AA-(CE)(Stable) rating » The borrower will take prior permission of the bank to effect any change in capital structure where the shareholding of the existing promoters (a) gets diluted below current level or (b) leads to dilution in controlling stake for any reason (whichever is lower)

» The borrower will give 60 days prior notice the bank for o formulation of amalgamation or reconstruction or merger or demerger o investment by way of share capital/loan/advance/deposit in any other concern » Promoter’s share in the borrower should not be pledged to any bank/NBFC/institution without bank’s permission

For the [ICRA]AA-(CE)(Stable) rating The above rating is based on the strength of the letter of comfort provided by IHEL that holds 51% stake of IHZL, for the rated bank lines. The Stable outlook reflects ICRA’s outlook on the rating of the support provider, IHEL.

Adequacy of credit enhancement For assigning the rating, ICRA has assessed the attributes of the letter of comfort issued by IHEL in favour of the said bank facilities. The letter of comfort is irrevocable, unconditional and constitutes legal and binding obligations on the support provider. It covers the entire amount and tenor of the rated facilities. With these attributes, the letter of comfort provided by IHEL Limited is considered as adequately strong to result in an enhancement in the rating of the said facilities to [ICRA]AA-(CE) against the rating of [ICRA]BBB+ without explicit credit enhancement. In case the rating of the support provider were to undergo a change in future, the same would reflect in the rating of the aforesaid facilities as well. The rating of these facilities may also undergo a change in a scenario whereby, in ICRA’s assessment, there is a change in the strength of the business linkages between the support provider and the rated entity or there is a change in the reputation sensitivity of the support provider to a default by the rated entity or there is a change in the strategic importance of the rated entity for the support provider.

Salient covenants related to the credit enhancement, as specified in the facility documents alongwith the letter of comfort

» The bank reserves the right to cancel the limits in occurrence of any or more of the following events (a) in case the limits are not/part utilised (b) deterioration of creditworthiness of borrower (c) non-compliance of terms and conditions of transaction documents by the borrower.

For the [ICRA]BBB+(Stable) rating The rating reaffirmation draws comfort from the favourable credit profile of the company’s shareholders- IHEL and Hitachi Zosen Corporation (HZC) as well as their established position in the engineering capital goods space. In addition to the technological expertise of its stakeholders that has enabled the company expand its product offerings, IHZL derives strengths from the continued marketing support that has allowed healthy incremental order flow in FY2019 as well as 9MFY2020. The rating continues to favorably factor in the company’s healthy order book which lends revenue visibility over the near to medium term, which coupled with lower debt levels is expected to allow company maintain satisfactory debt coverage metrics. IHZL also benefits from the location of its fabrication unit in Dahej, Gujarat, which being near a port enables efficient logistical management given sizeable supplies to global customers. The rating also considers the fact that the company follows a policy of hedging its foreign currency-denominated exposure which mitigates currency risks to a large extent.

However, the rating is constrained by the volatility of the company’s revenues given the lumpiness of order booking and the long order manufacturing cycle. The long order tenor as well as project completion based revenue recognition also results in sizeable inventory build-up leading to high working capital intensity of operations. Moreover, given the

company’s presence in niche product segments, its order book remains concentrated towards a few industries like petrochemicals, oil & gas and fertilisers, which results in linkage of IHZL’s business prospects with capacity investment plans of these sectors. The rating also remains constrained by the competitive pressures from both domestic and international players. These factors apart, the company’s profit margins remain exposed to the fluctuations in the prices of key raw materials, as equipment-supply contracts are typically fixed price in nature and the company’s long execution cycle.

Key rating drivers and their description

Credit strengths Established position of IHZL’s shareholders in the engineering capital goods space –IHEL and HZC, the JV partners in IHZL are reputed players in the engineering capital good space. IHEL has product offerings for capital goods including boilers, presses, pressure vessels, among others and caters to clients across 90 countries. Japan based HZC is a global player across various business verticals including industrial plants, environmental systems, process equipment, precision machinery among others. Both the entities have a strong market position in their respective geographies with a long track record of execution and client relationships.

Operational synergies with JV partners – Given the niche segments IHZL operates in and the need for licenses for the critical process equipment like reactors, convertors etc, its business generation is led by its JV partners for a retainership fee who also have significant involvement in operations through technical personnel stationed by them. Thus, the company benefits from operational synergies and client relationships of its shareholders. IHZL either receives direct orders facilitated by the JV partners or undertakes job work for their orders. This apart, the company’s manufacturing facility is in Dahej, Gujarat, which has a large port. This offers cost and logistics advantage by reducing transit time and expenses.

Healthy order book indicates adequate revenue visibility- IHZL’s order book stood Rs. 505 crore as on December 31, 2019 lending revenue visibility over the near to medium term. After strong order booking in FY2019, the company’s pace of order booking slowed down during 9MFY2020 largely on account of capacity constraints.

Healthy capital structure and satisfactory debt coverage metrics – IHZL enjoys a healthy capital structure having being well capitalised with an equity capital of Rs. 100 crore resulting in a debt equity ratio of 0.22 times as on March 31, 20192. This apart, given the continued inflow of customer advances for majority of its orders, the company’s dependence on external debt to fund working capital requirements has been limited. During FY2019, IHZL’s operating profit and cash accruals generation was lower in FY2019 following low revenue booking and thereby impacting debt coverage in the year (NCA/Debt of 22%, Interest coverage of 3.84 times). However, completion of orders over FY2020 and FY2021 would aid in increased scale of operations as well as some recovery in operating margins which in turn would result in improvement in debt coverage metrics (NCA/Adjusted Debt of 45-75% and Interest coverage between 4.5- 5.8 times over FY2020-22).

Credit challenges Volatility in revenues and long working capital cycle – In the backdrop of lumpy order booking coupled with longer order execution timelines as well as project completion based revenue recognition, the company’s revenues have been volatile

2 The company’s debt levels and gearing increased in H1FY2020 pursuant to recognition of lease liability of Rs. 76.4 crore as on April 1, 2019, as part of debt, as per AS 116 for lease accounting. The company’s facility at Dahej, Gujarat is on lease from IHEL. Further, the company’s operating profits in H1FY2020 is not comparable to that of FY2019. Adjusting for AS 116 related changes, the operating profit would be Rs. 8.7 crore resulting in operating margin at 8.8% in H1FY2020 on comparable basis.

in the past five years. IHZL witnessed modest order inflows between FY2017 and FY2018 (incremental orders of Rs. 448 crore over the two years) followed by a higher inflow in FY2019 (incremental orders of Rs. 475 crore) driven largely by capital additions in end user industries i.e. refinery and fertilisers. With long lead time for raw material procurements and significant fabrication process time results in an execution tenor of 15-18 months, a typical for capital goods manufacturer. In addition, project completion method of revenue recognition results in revenue volatility and also has a bearing on annual profitability. Consequently, while IHZL’s revenues declined to Rs 223.8 crore in FY2019 (Rs. 433.0 crore in FY2018), it registered revenues of Rs. 262.9 crore in 9MFY2020 after high order completions in Q3FY2020. ICRA expects the company to register a robust revenue growth of 35-40% in FY2020 led by multiple order completions besides a contracted base of FY2019. The growth is expected to moderate from FY2021 in line with the pace of order book replenishment and available capacity.

Given the revenue recognition method, the company’s working capital intensity is high during the order execution period with significant work in process inventory (NWC/OI of 49% in FY2019). The company, however, receives interest free customer advances across most orders enabling it to part fund these requirements. The ability to receive the same on a sustained basis and impact of any changes on the funding position will be a rating sensitivity.

Exposure to demand cyclicality in end user industries and competitive pressures–IHZL manufacturers niche products for specific industries namely fertilisers, oil refinery and petrochemicals, its order booking remains exposed to capital expenditure cycle in these industries adding to lumpiness. As on December 31, 2019, 80% of the company orders were towards the oil refinery sector. However, ICRA notes that the company has received approvals for a new product which finds applications in liquified natural gas plants. Order booking in this domain will result in some segment diversification in the long term. The company also remains exposed to competitive pressures from established players, however, this is partly mitigated by the strong market position of its JV partners who also lead business generation.

Exposure to input price risks- The profitability of the company remains exposed to fluctuations in the prices of key raw materials, given that the equipment-supply contracts that it enters into are typically fixed price in nature. However, as the manufacturing cycle is long, the company makes efforts to enter into back to back contracts for maximum portion of its bought out raw material (~60%) which partly mitigates this risk. The company’s operating margins have thus displayed a fluctuating trend over the past five years driven by product mix and ability to absorb raw material price fluctuations. Liquidity position

For the [ICRA]AA(CE)(Stable) and [ICRA]AA-(CE)(Stable) ratings: Strong In line with the support provider— IHEL. Please find the rationale here.

For the [ICRA]BBB+(Stable) rating: Adequate IHZL’s cashflows from operations turned negative in FY2019 and continued to remain negative in H1FY2020 on the back of growing working capital requirements led by high work in process inventory. However, the same were comfortably funded mainly through customer advances followed by incremental working capital borrowings. The company continues to have substantial drawing power and unutilised working capital limits which support its liquidity position. Thus, the company’s liquidity remains adequate.

Rating sensitivities For the [ICRA]AA(CE)(Stable) and [ICRA]AA-(CE)(Stable) rating The rating would be sensitive to any change in the rating of the guarantor/support provider.

For the [ICRA]BBB+(Stable) rating

Positive triggers: ICRA could upgrade the above long-term rating if the company demonstrates a considerable and sustained improvement in scale led by healthy order book build up and execution with improvement in profitability. Further, strengthening of credit profile of IHZL’s JV partners would also be considered for a rating upgrade.

Negative triggers: Negative pressure on the above ratings of IHZL could arise in the following scenarios (a) considerable decline in revenue due to lower order book execution, or reduction in profit margins and cash flow generation (b) weakening of liquidity profile led by sustained deterioration of working capital cycle (c) deterioration in credit profile of JV partners or weakening of linkages with them.

Analytical approach

Analytical Approach Comments Corporate Credit Rating Methodology Applicable Rating Methodologies Approach for rating debt instruments backed by third-party explicit support Impact of parent or group support on an Issuer’s credit rating Parent/Group Company: ISGEC Heavy Engineering Ltd and Hitachi Zosen Corporation. Parent/Group Support The ratings are based on both an explicit and implicit support from ISGEC Heavy Engineering Ltd; explicit support is provided for part of the facilities, whereas implicit support has been considered for others. Consolidation/Standalone Standalone

About the company Incorporated in March 2012, IHZL is a 51:49 JV between IHEL, India and HZC, Japan. The JV is involved in manufacturing specialised and critical process equipment for oil refining, fertiliser and petrochemical industries. IHZL benefits from the technological capability and customer base of its shareholding entities, IHEL and HZC, which are also responsible for the bidding/marketing function of the company. Collaboration with HZC has given it access to the licensed technology for building the aforesaid critical process equipment. The JV has a fabrication facility based in Dahej, Gujarat.

Key financial indicators (audited) FY2019 H1FY2020* Operating Income (Rs. crore) 223.8 99.6 PAT (Rs. crore) 2.0 0.4 OPBDIT/OI (%) 6.2% 23.0% RoCE (%) 4.4% 5.7%

Total Outside Liabilities/Tangible Net Worth (times) 1.30 1.10 Total Debt/OPBDIT (times) 2.19 3.26 Interest Coverage (times) 3.84 4.11 DSCR 1.58 4.01 *provisional financials

Status of non-cooperation with previous CRA: Not applicable

Any other information: None

Rating history for past three years

Rating (FY2020) Rating History for the Past 3 Years Current Earlier Instrument Amount Amount FY2019 FY2018 FY2017 Type Rating Rating Rated Outstanding 17-Mar 2020 11-Apr 2019 16-Apr 2018 28-Mar 2017 Fund-based Long [ICRA]AA(CE) [ICRA]AA(SO) [ICRA]AA(SO) [ICRA]AA(SO) 1 130.0 - limits Term (Stable) (Stable) (Stable) (Stable) Non-fund Long [ICRA]AA(CE) [ICRA]AA(SO) [ICRA]AA(SO) [ICRA]AA(SO) 2 355.0 - based limits Term (Stable) (Stable) (Stable) (Stable) Fund / non- Long [ICRA]AA(SO) [ICRA]AA(SO) 3 fund based - - - - Term (Stable) (Stable) limits Fund-based Long [ICRA]AA- [ICRA]AA-(S) [ICRA]BBB+ 4 10.0 limits Term (CE) (Stable) (Stable) (Stable) Non-fund Long [ICRA]BBB+ [ICRA]BBB+ [ICRA]BBB+ [ICRA]BBB+ 5 25.0 - based limits Term (Stable) (Stable) (Stable) (Stable) Non-fund Long [ICRA]AA- [ICRA]AA-(S) [ICRA]BBB+ 6 20.0 - based limits Term (CE) (Stable) (Stable) (Stable) Long [ICRA]BBB+ 7 Term loan 20.0 20.0 - Term (Stable) Unallocated Long [ICRA]BBB+ [ICRA]BBB+ [ICRA]BBB+ [ICRA]BBB+ 8 10.0 - limits Term (Stable) (Stable) (Stable) (Stable) Amount in Rs. Crore

Complexity level of the rated instrument ICRA has classified various instruments based on their complexity as "Simple", "Complex" and "Highly Complex". The classification of instruments according to their complexity levels is available on the website click here

Annexure-1: Instrument details ISIN Instrument Name Date of Coupon Maturity Amount Current Rating Issuance / Rate Date Rated and Outlook Sanction (Rs. crore) NA CC/EPC/PCFC/FBP/FBD - - - 130.0 [ICRA]AA(CE) (Stable) NA LC/BG/SBLC - - - 355.0 [ICRA]AA(CE) (Stable) NA CC/WCDL/EPC/PCFC/IBD/FBD - - - 10.0 [ICRA]AA-(CE) (Stable) NA BG - - - 25.0 [ICRA]BBB+ (Stable) NA LC/BG/SBLC - - - 20.0 [ICRA]AA-(CE) (Stable) NA Term loan Jul 2019 1year Sep 2024 20.0 [ICRA]BBB+ MCLR + (Stable) 0.80% NA Unallocated limits - - - 10.0 [ICRA]BBB+ (Stable) Source: IHZL

Annexure-2: List of entities considered for consolidated analysis

Not applicable

Corrigendum

Document dated March 17, 2020 has been corrected with revisions as detailed below:

• Details on adequacy of credit enhancement- Page 1 and Page 2 • Added outstanding rating of IHEL, Page 1 footnote • Relationship contact has been changed from Jayanta Chatterjee to L Shivakumar, along with the contact details – Page 9

Analyst Contacts Sabyasachi Majumdar Anupama Arora +91 124 4545 304 +91 124 4545 303 [email protected] [email protected]

Sheetal Sharad +91 124 4545 374 [email protected]

Relationship Contact L Shivakumar +91 22 6114 3406 [email protected]

Media and Public Relations Contact Ms. Naznin Prodhani Tel: +91 124 4545 860 [email protected]

Helpline for business queries: + 91-9354738909 (open Monday to Friday, from 9:30 am to 6 pm) [email protected]

About ICRA Limited ICRA Limited was set up in 1991 by leading financial/investment institutions, commercial banks and financial services companies as an independent and professional investment Information and Credit Rating Agency.

Today, ICRA and its subsidiaries together form the ICRA Group of Companies (Group ICRA). ICRA is a Public Limited Company, with its shares listed on the Bombay Stock Exchange and the National Stock Exchange. The international Credit Rating Agency Moody’s Investors Service is ICRA’s largest shareholder.

For more information, visit www.icra.in

ICRA Limited Corporate Office Building No. 8, 2nd Floor, Tower A; DLF Cyber City, Phase II; Gurgaon 122 002 Tel: +91 124 4545300 Email: [email protected] Website: www.icra.in

Registered Office 1105, Kailash Building, 11th Floor; 26 Kasturba Gandhi Marg; New Delhi 110001 Tel: +91 11 23357940-50

Branches

Mumbai + (91 22) 24331046/53/62/74/86/87 Chennai + (91 44) 2434 0043/9659/8080, 2433 0724/ 3293/3294 Kolkata + (91 33) 2287 8839 /2287 6617/ 2283 1411/ 2280 0008 Bangalore + (91 80) 2559 7401/4049 Ahmedabad+ (91 79) 2658 4924/5049/2008 Hyderabad + (91 40) 2373 5061/7251 Pune + (91 20) 020 6606 9999

Contents may be used freely with due acknowledgement to ICRA.

ICRA ratings should not be treated as recommendation to buy, sell or hold the rated debt instruments. ICRA ratings are subject to a process of surveillance, which may lead to revision in ratings. An ICRA rating is a symbolic indicator of ICRA’s current opinion on the relative capability of the issuer concerned to timely service debts and obligations, with reference to the instrument rated. Please visit our website www.icra.in or contact any ICRA office for the latest information on ICRA ratings outstanding. All information contained herein has been obtained by ICRA from sources believed by it to be accurate and reliable, including the rated issuer. ICRA however has not conducted any audit of the rated issuer or of the information provided by it. While reasonable care has been taken to ensure that the information herein is true, such information is provided ‘as is’ without any warranty of any kind, and ICRA in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness or completeness of any such information. Also, ICRA or any of its group companies may have provided services other than rating to the issuer rated. All information contained herein must be construed solely as statements of opinion, and ICRA shall not be liable for any losses incurred by users from any use of this publication or its contents.