August 19, 2019 Mohan Meakin Limited: Ratings upgraded with revision in outlook Summary of rating action Previous Rated Current Rated Amount Instrument* Rating Action Amount (Rs. crore) (Rs. crore) Long-term: Fund Based/Cash [ICRA]BBB; upgraded from [ICRA]BBB-; 65.00 65.00 Credit Outlook revised to Positive from Stable Short-term: Non-fund Based 5.00 10.00 [ICRA] A3+, upgraded from [ICRA] A3 Long-term/Short-term: 5.00 - - Unallocated Total 75.00 75.00 *Instrument details are provided in Annexure-1 Rationale The rating action reflects sustained improvement in Mohan Meakin Limited’s (MML) operational performance and financial profile, supported by improving utilisation of its manufacturing capacities (IMFL1 as well as brewery) and higher profitability. MML’s revenues grew by ~26% YoY to Rs. 659.89 crore in FY2019, aided by increased sales volumes owing to geographic diversification and product expansion in the liquor segment, and price increases in a few states. The strong revenue growth in FY2019 helped in absorption of fixed overheads. This, along with the company’s continued focus on cost rationalisation, resulted in a strong growth in its profits. Strong cash accruals resulted in an improved liquidity position and reduced dependence on external debt, strengthening its capital structure. While the company has expansion plans to ramp up its brewery operations, ICRA expects its strong capital structure and healthy debt protection metrics to sustain because of limited dependence on external debt to fund the capex plans. Besides an increase in scale, the capex is likely to strengthen MML’s operational profile by improving process efficiencies and strengthening its market presence and reducing its product concentration. The ratings continue to factor in MML’s large and favourably located land bank, a part of which the company plans to monetise to fund any future large capex requirements going forward. The ratings, however, are constrained by the company’s high overheads and limited efficiencies in its manufacturing operations because of its vintage. These have resulted in subdued margins for the company in the past. Moreover, the company’s operating profitability witnessed some moderation in Q1FY2020 due to temporary shutdown of its Kasauli unit for installation of effluent treatment plant in the mentioned period. The ratings also factor in the concentration risks arising out of high dependence on a single brand – Old Monk – for most of its sales, and limited presence of the company in other product categories. Further, the company is exposed to raw material availability and pricing risk, given the current uptick in ENA2 prices and the company’s increased reliance on outside purchase of spirits. Though MML has demonstrated its ability to maintain its operating margins despite pressure on operating margins in FY2019, its ability to do so on a consistent basis, remains imperative. Additionally, the ratings are constrained by the high business risk inherent in the liquor industry owing to high taxes, stringent Government controls and regulations, and limited pricing 1 IMFL: Indian-made foreign liquor 2 ENA: Extra Neutral Alcohol 1 power. Notwithstanding these concerns, ICRA draws comfort from MML’s operating track record of over 15 decades in the Indian liquor industry, the established brand presence of its flagship brand – Old Monk – in the rum segment, its strong nation-wide presence and favourable long-term volume outlook for the industry. Going forward, the company’s ability to maintain its enhanced profitability margins and comfortable capital structure amid the highly regulated industry environment shall be the key rating sensitivities. Outlook: Positive The Positive outlook reflects ICRA’s expectation of further strengthening of the company’s financial risk profile supported by healthy revenue growth, established brand equity, product launches and favourable long-term volume outlook for the industry. Further, the company plans to augment its brewery operations in FY2020, which would support its medium- term growth plans. The outlook may be revised to Stable if the margins or accruals are lower than expected, or if there is material deterioration in margins, or if any major unbudgeted debt-funded capital expenditure, or stretch in the working capital cycle weakens liquidity. Any unforeseen regulatory change will also be a key rating sensitivity. Key rating drivers Credit strengths Experienced management; reputation in industry: The management has extensive experience in the liquor manufacturing industry. The Mohan family took over the company’s operations in 1949, and since then it has been one of the well-known players in the Indian liquor industry. Sustained improvement in revenues and profitability: With an increase in sales volumes following geographic coverage and product expansion, MML’s operating income (OI) and profitability has consistently improved. The company’s revenues registered a healthy growth of 26% to Rs. 659.89 crore in FY2019 from Rs. 523.68 crore in FY2018, while the profitability strengthened to 7.68% in FY2019 from 3.54% in FY2018, albeit modest levels. However, the company’s operating profitability witnessed some moderation in Q1FY2020 due to temporary shutdown of its Kasauli unit for installation of effluent treatment plant in the mentioned period. Significant reduction in debt levels and improvement in capitalisation and coverage indicators: Healthy net cash accruals in FY2019 and FY2018 resulted in lower dependence on external funds for working capital. As a result, there was a significant reduction in the company’s debt levels in the past two years. Correspondingly, there was an improvement in capitalisation and coverage indicators for the company with both the gearing and Debt/OPBITDA comfortable at below 1 times as on March 31, 2019. Established brand with pan-India presence; however, brand concentration towards Old Monk remains: The company has an extensive operational track record and an established pan-India presence in the domestic IMFL market through its flagship brand, Old Monk. Nonetheless, Old Monk accounts for more than 90% of the total IMFL sales, which exposes it to product-concentration risk. Favourable demand outlook: India’s liquor industry is expected to record the second fastest growth globally. At present, the Indian alcohol industry is characterised by per capita consumption of 5.1 litres per annum, which is considerably lower than the Asian per capita average of 20.9 litres. The industry’s growth is expected to be supported by favourable 2 demographics, rising disposable incomes and urbanisation. These growth drivers are expected to support the company’s revenues. High entry barriers and strong hold in defence segment: While the highly regulated nature of the industry with substantial Government controls on advertising and taxes restrict growth to a certain extent, the same creates entry barriers for new players, thereby favouring incumbents. Further, MML is one of the suppliers of branded IMFL to the Canteen Stores Department (CSD), which has significant business barriers to entry. Credit challenges Limited operational efficiencies result in modest profitability: The company’s operational profile remains modest as reflected by low capacity utilisation due to plants of relatively older vintage, which has in turn resulted in high production costs. As a result, the margins have remained relatively low in the past. The company has high overheads which also suppress profit margins. Exposure of profitability margins to volatility in raw material prices: The company’s margins remain dependent on price trends of major raw materials like molasses and grains. The raw material prices are governed by various factors, including the supply of molasses and grains, which is in turn depend upon production, Government regulations, demand from other sectors like biodiesel, etc. The risk is further intensified by the fact that the product prices for a particular financial year are decided at the beginning of the year itself by the respective state government. Hence the company’s ability to pass on any raw material price increase during the year remains limited. High competitive intensity and highly regulated nature of industry: MML’s revenues will continue to be impacted by increasing competition in the domestic market from global players, particularly in the premium segment. In addition, the company remains exposed to changes in pricing by state governments. Strong government controls, ban on advertising, varying tax structures in different states pose challenges and restrict growth of the industry Project risks associated with large capital expenditure plans in Hathras, UP: The company had been allotted land on lease at Hathras, UP from UPSIDC3; however, proper possession of the same has not been received. ICRA will continue to monitor the progress on the possession of the land, and any further capex on it and its impact on the company’s financial profile. Liquidity position MML has a strong liquidity position with healthy cash accruals and moderate working capital cycle. The company’s debt largely comprises working capital limits from the bank. Its liquidity position is supported by healthy internal accrual generation and limited debt repayment liability. In addition, its liquidity profile is further supported by the availability of sufficient bank limits for company’s working capital requirements. Additionally, MML maintained a comfortable current ratio as on March 31, 2019. 3 Uttar Pradesh