Press Release Lava International Limited (Revised) May 11, 2020 Ratings Amount Facilities Rating1 Rating Action (Rs. crore) CARE BBB; Stable Revised from CARE BBB+; Long term Bank Facilities 324.55 (Triple B; Outlook:Stable) Stable(Triple B Plus) CARE A3+ Revised from CARE A2 (A Short term Bank Facilities 975.00 (A Three Plus) Two) 1299.55 (Rs. One Thousand Two Hundred Total Facilities and Ninety- Nine Crore and Fifty- Five lakhs Only) Details of instruments/facilities in Annexure-1 Detailed Rationale & Key Rating Drivers The revision in the ratings assigned to the bank facilities of Lava International Limited (Lava) takes into account the decline in the operational performance of the company and moderation in the liquidity profile of the company as reflected by decline in free cash and bank balance. The ratings also take into cognizance considerable underachievement in the profitability of FY19 as against the figures envisaged during the last rating exercise. The ratings also factor in intense competition in the mobile handset industry, inherent risks related to the nature of business operations which include reliance on third-party suppliers for products/services and its susceptibility to foreign exchange fluctuation risk. The ratings, however, continue to derive strength from experienced promoters and management teams, a wide distribution network, and comfortable financial risk profile. Going forward, profitable scale-up of operations with efficient working capital management and adapting to changing consumer preferences and technological evolutions shall remain the key rating sensitivities. Rating Sensitivities Positive factors Sustained increase in operating income beyond Rs. 4000 Cr. Sustained improvement in PBILDT margin above 6.5%. Negative Factors Sustained decline in operating income beyond Rs. 2000 Cr. Decline in PBILDT margin below 3%. Increase in working capital cycle beyond 100 days. Detailed description of the key rating drivers Key Rating Strengths Experienced Promoters and management team Lava is promoted by Mr. Hari Om Rai, Mr. Shailendra Nath Rai, Mr. Vishal Sehgal and Mr. Sunil Bhalla. Mr. Hari Om Rai, Chairman and MD of the company is co-chairing the task force for “Make in India” program of the Government of India. All the promoters are part of the Board of Directors of the company and have background in engineering and management studies with wide experience in various fields. The board is ably supported by a team of highly qualified and experienced people from telecom and consumer durable industry. Wide distribution network and streamlined business operations; albeit rationalisation of distribution channel Lava has a well-established distribution model and support-service network consisting of 1,100+ distributors, who further distribute products to 1,10,000+ and micro-distributors across India along with 42 Carrying & Forwarding agents providing sales and distribution support. Due to strong distribution channel, feedback about the models reaches to R&D team fast, helping them with adapting to designing and technology trend Comfortable Capital Structure and debt coverage indicators Lava’s capital structure continues to remain comfortable as on March 31, 2019 (Aud) as well as March 31, 2020 (Provisional) on account of healthy net worth and low debt. The company’s term debt has decreased from Rs. 68.10 crore as on March 31, 1Complete definition of the ratings assigned are available at www.careratings.com and other CARE publications 1 CARE Ratings Limited Press Release 2018 to Rs.27.08 crore as on March 31, 2019 after repayment of ~ Rs. 41 cr in FY19 resulting in decrease in debt-equity ratio to 0.08 (PY: 0.13). Also, LC backed creditors of the company decreased from Rs. 429.05 crore as on March 31, 2018 to Rs.218.56 as on March 31, 2019 and to Rs. 174.70 cr as on March 31, 2020. Due to which the overall gearing (including LC backed creditors) has improved and stood at 0.34x as on March 31, 2019 (0.66x times as on March 31, 2018) and 0.32x as on March 31, 2020 (Prov). Key Rating Weakness Moderation in growth in the operations Income: The total operating income of the company declined by 7% during FY19 to Rs. 3083 crore from Rs. 3310 cr in FY18. The moderation in the income was primarily on account of decline in the Average selling price of its handset though the volume remained stable during FY19. Lava has been facing continuous decline in its realization owing to competition in the market from various Chinese players. The revenue has further moderated by 37% during FY20 (prov) primarily on account of change in product mix due to shift in focus from smart phone to feature phone leading to decline in average selling price of its products. This has helped company to improve its profitability during FY20. Profitability: The PBILDT margin witnessed deterioration of 115 bps during FY19. The PBILDT margins of the company have been under pressure and has reduced from 7.20% in FY17 to 3.21% in FY19 on account of continuous fall in average sales price of its handsets. Furthermore, there has been a significant underachievement of PBILDT during FY19 as against the envisaged figures during last rating exercise. However, the PBILDT margin has improved to 4.85% in FY20 (Prov) an improvement from FY19 (A) (PY: 3.22%). The company has been focusing more on feature phones (where it has been able to do more localization) in order to increase its profitability margins. During H1FY19 the company manufactured 7.16 million feature phones and 2 million smart phones while during H1FY20 it manufactured 7.33 million feature phones and only 0.86 million smart phones. Moderation in Liquidity The liquidity position of the company stood moderate as on March 31, 2019 and has been on a declining trend since last three years. The free Cash and bank balance of the company stands at Rs. 115.59 crore as on March 31st 2019 (PY: Rs. 306.19 crore). The same reduced further to Rs.67.36 crore as on December 31, 2019. The operating cycle of the company has increased to 54 days in FY19 from 44 days in FY18 due to higher collection period which has increased to 74 days (PY: 60 days). It has further increased to 107 days during FY20 (prov) on account of continued rise in collection period which was due to higher credit period required in trading of mobile accessories business in which the company entered in last two years. Furthermore, the debtors for more than six months have increased considerably thereby indicating a large amount of capital stuck in the operating cycle and exposing the company to higher counterparty risk. Reliance on third-party suppliers for its majority of raw material requirement Lava is dependent on the third party suppliers for its raw material requirements. This is on account of undeveloped ecosystem of production capacities and technology at present in the country. As per the business model, it now started manufacturing the products from the Completely Knocked Down units (CKDs) to produce Completely Built Units (CBUs). Despite that, as majority of sourcing is being made through third-party vendors located in China/Hong-Kong, it exposes the company to inherent risks. However, with recent developments in the manufacturing capacities of company and company’s increased focus on manufacturing handsets in India it has stared procuring approx. 30% raw material locally. Going forward, the reliance of the company on supplier for raw material is expected to reduce further. Foreign Exchange exposure Lava is exposed to foreign exchange rate risk on account of import of CKDs and CBUs from OEM partners based in China/Hong Kong. As a policy, the company maintains buffer (of 2-3%) in prices for any adverse forex movement; further, based on the management’s insights and market information, the company enters into hedging to cover part of its foreign exchange risk. Due to the currency fluctuations company reported exchange rate loss of Rs. 11.01 crore during FY19 (Rs.4.99 crore in FY18). Furthermore, the company tends to pass-on the increase in cost by increasing the price of the handsets. Highly competitive Indian handset industry and Intellectual Property Issues The Indian mobile handset industry is marked by high level of competition with the market being highly price sensitive and value driven. The industry is fragmented with both domestic and foreign players competing, leading to stiff price competition. Given the huge opportunity in smart phones and low entry barriers, many new players have entered the industry. Aggressive online and offline sales recorded by new players like Xiaomi, Oppo and Vivo has substantially altered the market share scenario in the industry. However the risk is mitigated to some extent as Lava is primarily engaged in feature 2 CARE Ratings Limited Press Release phone segment and is focussing on securing orders from International and domestic markets to maintain its position in the industry. The sector is also exposed to Intellectual Property (IP) challenges raising the chances of infringement and IP conflicts. Lava is building its R&D capabilities and following backward integration strategy in order to work towards designing and manufacturing the entire range of Lava mobiles in India. Liquidity: Adequate The liquidity profile remains adequate characterized by sufficient cushion in accruals vis-à-vis repayment obligations. The working capital limits remain are utilized by 80 % for the last 12 months ended on January, 2020 and had free cash balance of Rs. 115.59 crore as on March 31st 2019 (PY: Rs. 306.19 crore) and Rs.67.36 crore as on December 31, 2019. The company has availed moratorium facility as per RBI- COVID-19 guidelines. Analytical approach: Standalone Applicable Criteria Criteria on assigning Outlook to Credit Ratings CARE’s Policy on Default Recognition Criteria for Short Term Instruments Rating Methodology- Manufacturing Companies Financial ratios – Non-Financial Sector About the Company Incorporated in 2009, Lava is promoted by Mr Hari Om Rai, Mr Sunil Bhalla, Mr Shailendra Nath Rai and Mr Vishal Sehgal.