July 29, 2021 Pricol Engineering Industries Limited: Ratings reaffirmed; outlook revised to positive Summary of rating action Previous Rated Amount Current Rated Amount Instrument* Rating Action (Rs. crore) (Rs. crore) [ICRA]BB+ reaffirmed; Long-term - Term Loan 6.00 0.90 outlook revised to Positive from Stable [ICRA]BB+ reaffirmed; Long-term fund-based 5.00 6.00 outlook revised to Positive from Stable [ICRA]BB+ reaffirmed; Long-term fund based (USD 0.75 million) (USD 0.121 million) outlook revised to Positive (sublimit)# from Stable [ICRA]BB+ reaffirmed; Long Term Working capital - 1.82 outlook revised to Positive demand loan from Stable Short-term non-fund Based 7.50 10.00 [ICRA]A4+ reaffirmed Long-term/ Short-term fund- (2.50) - based facilities (sublimit) Long-term/ Short-term non- fund-based facilities (7.50) - (sublimit) [ICRA]BB+/[ICRA]A4+ Long-term/ Short-term 21.50 21.28 reaffirmed; outlook revised unallocated facilities to Positive from Stable Total 40.00 40.00 *Instrument details are provided in Annexure-1 # - Although the facility is denominated in foreign currency, which is US$ equivalent of the Long-Term loan mentioned above, ICRA’s rating for the same was on national scale as distinct from international rating scale. Rationale The revision in the outlook on the long term rating from stable to positive reflects ICRA’s expectation that factors in improvement in the operating environment in the current fiscal, Pricol Engineering Industries Limited (PEIL) addition of new marquee clients in the defence sector which promises revenue growth, as well as the timely collection in debtors in the current fiscal as evidenced from the fact that it has come down from Rs 24 crore as on March 31, 2021 to Rs 13 crore as on June 30, 2021. The revision in outlook also takes into account that despite the lockdown related disruptions in Q1FY2022, the company has been able to achieve revenues of Rs 20.27 crore, showing only a marginal decline sequentially over Q4 FY2021. ICRA believes that the company will also continue to derive comfort from the extensive experience of PEIL’s promoters in the auto industry and their established relationships with customers. The ratings reaffirmation of PEIL draws comfort from its diversified business profile with presence in railways, defence and auto segments with a wide array of products including hull electrical equipment and driver panel for T-72 armoured tank for defence; electrical control cabinet and cable harnesses for railways; and alternators, oil pressure switches and wind shield washer kits for the auto component segment. The ratings also consider the company’s comfortable capital structure with a gearing of 0.3 times as on March 31, 2021 (0.4 times as on March 31, 2020). Also, the Pricol brand has a good connect in the auto component segment, which PEIL leverages while tapping customers in the auto sector. The ratings are also supported by the reputed client profile comprising auto OEMs like Tata Motors Limited, TAFE, and Mahindra and Mahindra to name a few. The company has also improved its profitability in FY2021 despite the pandemic related disruptions through cost rationalisation, which also resulted in a healthy liquidity profile. www.icra .in Page | 1 However, the ratings are constrained by PEIL's small scale of operations, exposing the company to increased vulnerability during the periods of downturn. Additionally, a decline in revenues in the last two years due to challenging operating environment and headwinds in the auto sector, which is the largest revenue generating segment, adversely impacted its business performance. The company’s tender-based orders in the defence and railway sectors lead to less revenue visibility and temper profit margin. Also, an increase in the working capital intensity in FY2021 due to delayed payments from customers has constrained the ratings. Although PEIL’s customer concentration has reduced from the previous levels with diversification in the non-wiping auto component segment, it continues to remain high with the top five customers contributing 74% to revenues. Key rating drivers and their description Credit strengths Diversified product portfolio with presence in the auto component, railways and defence sectors – PEIL has presence in the defence, railways and auto component industries and manufactures various products such as hull electrical equipment, driver panels and instrumental clusters, cable harnesses, alternators, oil pressure switches and wind shield washer kits to name a few, under the umbrella ‘Pricol’ brand. The company’s revenues, which were earlier concentrated in the defence and railways segments leading to limited revenue visibility owing to the tender-based nature of contracts, have now diversified across the defence and railways (~40% revenues in FY2021) and auto component (~60% revenues in FY2021) sectors. Reputed client profile comprising auto OEMs like Tata Motors Limited, TAFE, and Mahindra and Mahindra– The company’s client profile comprises auto original equipment manufacturers (OEMs) like Tata Motors Limited, Tractors and Farm Equipment Limited, Mahindra & Mahindra Limited and Daimler India Commercial Vehicles Private Limited to name a few. In railways, PEIL supplies to the controller of stores, Chennai which is owned and operated by the Indian Railways. In the defence segment, PEIL caters to Heavy Vehicle Factory and Ordnance Factory, Medak. PEIL is also on track to add new customers in the auto segment in FY2022. Long track record of the promoters in the manufacturing business – PEIL was established in 1995 and has been involved with the business of manufacturing products for defence and railways since its inception. Given the long experience of the promoters in the industry and PEIL’s established operational track record, the company has been able to develop a wide network of suppliers and customers. The company benefits from the established brand name, Pricol, which has a strong recall with customers in the auto component segment. Comfortable financial risk profile – PEIL’s capital structure is comfortable with a gearing of 0.30 times and TOL/TNW of 1.5 times as on March 31, 2021 owing to the repayment of term loans. As on March 31, 2021, the total debt stood at Rs. 8.5 crore, and the company had free cash and liquid investments of Rs. 10.6 crore making it net debt negative. The coverage indicators have also improved on the back of improving profitability over the years with the interest coverage at 5.2 times in FY2021 against 1.2 times in FY2020. NCA/TD1 turned positive at 44% in FY2021 from -5.6% in FY2020 and DSCR2 stood at 1.00 times in FY2021 against 0.2 times in FY2020. Credit challenges Small scale of operations and thin margin remain vulnerable to escalation in raw material costs – PEIL, with an operating income of ~Rs.76 crore in FY2021 and ~Rs. 93 crore in FY2020, has a small scale of operations. The total net worth of the company is also low at Rs. 27.2 crore in FY2021. However, the operating margins improved to 6.5% in FY2021 against 1.8% in FY2020, supported by cost rationalisation measures implemented by the company. ICRA notes that despite this improvement 1 Net cash accruals to total debt 2 Debt service coverage ratio www.icra .in Page | 2 in margins, PEIL’s profitability is susceptible to unfavourable raw material price movements as there is limited flexibility to pass on the price increase to customers. Increase in working capital intensity due to delayed payments from customers in FY2021 – The company’s working capital intensity increased to 16.3% in FY2021 from 11.2% in FY2020 on the back of higher debtor days, which increased to 119 days in FY2021 from 49 days in FY2020. This deterioration was on the back of the pandemic related disruptions. Collections are expected to pick up in the current fiscal following the gradual improvement in the health of end-user industries in FY2022. Currently the debtors have come down from Rs 24 crore as on March 31, 2021 to Rs 13 crore as on June 30, 2021 which would reduce the working capital intensity. Additionally, ICRA notes that in FY2021, when receivables witnessed a sharp increase, PEIL was able to get favourable payment terms with creditors, which limited its dependence on external borrowings to fund the build-up in current assets. Decline in revenues in FY2021 because of Covid-19 pandemic; volatility in revenues from railways and defence segments as orders are tender based – The company’s revenues declined in FY2020 and FY2021 on the back of lower auto demand in FY2020 and pandemic related disruptions in FY2021. However, its revenues are expected to grow in FY2022 despite a month- long lockdown in the states where PEIL operates, on the back of improving demand from the auto sector. However, with 35- 40% of PEIL’s revenues derived from the defence and railways segments where orders are tender based, revenue visibility in these segments remains low, leading to volatility in turnover and profits. However, the company is associated with marquee names such as Tata, Mahindra and L&T during Q1FY2022 in the defence sector which which promises revenue growth in future. High customer concentration, though share of top five customers reducing in FY2021– PEIL’s concentration with top five customers reduced to 74% in FY2021 from 97% in FY2017, aided predominantly by addition of new customers in the auto component segment. Nevertheless, the customer concentration remains high, indicating vulnerability of revenues to any slowdown in orders from the clients or shifting of customers to competitors. However, established relationships with customers and history of repeat orders mitigate the risk to an extent. Liquidity position: Adequate PEIL’s liquidity is adequate with an average utilisation of 68.0% of its working capital limits over the last 15 months ending June 30, 2021.