March 23, 2003 | Financial Express

Tata Engineering and Locomotive Company Ltd

Rs 2.50 billion non-convertible debenture issue: Upgraded to AA from AA-
Rs 1.42 billion non-convertible debenture issue: Upgraded to AA from AA-
Rs 1.32 billion non-convertible debenture issue: Upgraded to AA from AA-
Rs 12 billion short-term debt programme: P1+ Reaffirmed
Rs 4.15 billion fully convertible short-term debenture issue: P1+ Rating withdrawn

The rating revision is based on the benefits that Tata Engineering and Locomotive Company Ltd (Telco) is now reaping because of the extensive financial and business restructuring undertaken by its management over the last three years. The chief benefits that have begun to emerge in Telco’s credit risk profile are the large reduction in its working capital levels, the reduction in its fixed costs, improvements in operating efficiency and the consequent reduction in its break-even volumes for both the commercial vehicles and passenger cars businesses.

The profit benefit arising from these measures has been amplified by the extremely strong volume growth in the commercial vehicles business in the financial year (FY) 2002-2003 and the steadily improving volumes of the passenger car business over the last two years. Consequently, Telco is likely to achieve a significant reduction in its debt levels by the end of 2002-2003 and a robust improvement in its debt protection ratios. Crisil expects Telco’s gearing (as measured by adjusted debt to tangible networth) to be around 0.75 times as at March 31, 2003 (as compared to 1.18 times as at March 31, 2002), its net cash accruals to total debt to be around 30-35 per cent in 2002-2003 (around 20 per cent in 2001-2002) and its interest coverage to be 3.3 times in the same year (1.7 times in 2001-2002).

In Crisil’s opinion, the company’s financial risk profile could improve further if the currently strong volumes in the commercial vehicle market are sustained as indeed if its model variants on the Indica platform are able to significantly improve its passenger car plant’s present capacity utilisation levels. These possibilities have not, however, been factored into the current ratings.

The rating also continues to derive comfort from the company’s access to financial support from the Tata group as evident in the latter’s subscription to Telco’s rights issue in 2001-2002 and the fact that the company’s debt repayments over the next three years are small in relation to its expected business inflows.

Ongoing financial and business restructuring has reduced break-even levels: Telco has achieved substantial cost reductions of over Rs 9 billion over the last three years, which has enabled it to greatly reduce the fixed cost intensity of its operations. This, in turn, has resulted in a steep decline in the break-even volumes and an improvement in the operating profitability of all its businesses. Its current break-even levels are estimated to be below 70,000 units in the commercial vehicles business and a little over 1,00,000 units in the passenger car and multi-utility vehicle (MUV) business.

Telco’s cost reduction measures have largely centred on material cost savings, extensive manpower rationalisation and interest cost savings. The material cost reductions have been primarily driven by the company’s efforts towards value engineering, vendor rationalisation and better supply chain management. The company has also reduced its manpower strength by over 5000 employees over the last three years, leading to lower fixed costs. Consequently, Telco’s operating margins are estimated to be over 12 per cent in 2002-2003 as compared to 8.7 per cent in 2001-2002.

The management’s efforts to reduce its working capital have also led to large savings in interest costs. Telco’s debtor levels (measured as receivables and bills discounted in days of operating income) are estimated to be around 22 days as at March 31, 2003, as compared to around 46 days as at March 31, 2002. Similarly, there has been a steady reduction in the company’s inventory levels (measured as days of cost of sales) over the last two years. Its inventory levels are estimated to be around 49 days as at March 31, 2003, as compared to 62 days as at March 31, 2001. Telco has also been working on streamlining its supplier payment system, which has also contributed to its operating margins (because of higher cash discounts) without affecting its credit cycle.

Telco’s debt restructuring efforts have also resulted in lower interest costs. Telco has prepaid around Rs 7.5 billion worth of high-interest-bearing debt over the last two years. Moreover, the company’s debt would reduce to an estimated Rs 17 billion as at March 31, 2003, from around Rs 30 billion as at March 31, 2001, on account of higher cash accruals (estimated to be over Rs 6.5 billion in 2002-2003 over around Rs 3.5 billion last year) and better working capital management.

Strong volume growth in medium and heavy commercial vehicles has significantly strengthened business inflows in 2002-2003: The strong growth in Telco’s medium and heavy commercial vehicle (M&HCV) sales volumes in the current year has resulted in large cash accruals, which has aided the company’s ongoing debt reduction efforts. Moreover, Telco’s product offerings in this segment are in sync with changing market requirements such as the increasing demand for multi-axle vehicles. The company recently launched its EX series of HCV, which aims to meet future customer requirements and offers better fuel efficiency, power-to-weight ratio and comfort and safety-related features. Telco is also gearing up to meet the changing needs of the customers in the bus segment and proposes to launch a range of buses in various segments. Thus, Crisil expects Telco to maintain its strong market position in the M&HCV segment in the future.

Market position remains under pressure in light commercial vehicles: Despite the high growth in Telco’s light commercial vehicle (LCV) volumes in 2002-2003, the company’s market share continues to remain under pressure. This is mainly due to the fact that Telco has lagged other industry players in offering an acceptable product in the growing sub-four tonne category. Players like Mahindra and Mahindra Ltd, on the other hand, have witnessed strong growth and gained market share in this segment. In the current year, Telco has introduced its 207 DI in the sub-four tonne category, which has enabled it to moderate the decline in its market share as compared to previous years. Telco is, however, unlikely to retain its dominant market share in the LCV market over the medium term in the face of intense competitive pressures.

Improving volumes in the passenger car business have made it profitable, albeit only marginally: Telco’s passenger car business continued to perform strongly in 2002-2003 with high volume growth and a significant improvement in profitability. Consequently, this business is no longer a drag on the company’s business inflows. Moreover, the uncertainty related to its products’ acceptance by consumers has been put to rest as evident from the Indica’s higher-than-industry volume growth over the last two years. The company’s strategy to expand its volumes through new variants on the Indica platform is also sound. The recent launch of the Indigo in the C-segment and Telco’s plans to launch Indica Estate and Indica Sport in 2003-04, if successful, would significantly improve the car business’ profitability. Moreover, Telco’s success in its export initiatives is likely to result in better capacity utilisation and, therefore, higher profitability.

Performance in MUV segment dependent on new model strategy: Telco’s MUV sales volumes have been largely stagnant in 2002-2003 as the increase in Safari volumes has been offset by the decline in Sumo volumes. Telco’s performance in this segment is expected to remain sluggish over the medium term. The company’s ability to match the new model launches by its competitors will critically determine its long-term business position in the MUV market.

Improving financial risk profile: Telco has managed to reduce its debt over the last three years. Its debt levels are estimated to fall to around Rs 17 billion as at March 31, 2003, from around Rs 30 billion as at March 31, 2001, driven by high cash accruals and lower working capital levels. Consequently, Telco’s gearing (as measured by debt adjusted for bills discounted/networth) would improve significantly to an estimated 0.75 times as at March 31, 2003, from 1.18 times as at March 31, 2002. Telco is expected to largely meet its planned capital expenditure requirement of Rs 13 billion over the next two years through internal cash accruals. Moreover, the financial performance of most of Telco’s subsidiaries has also improved in 2002-2003 and its combined debt in the subsidiaries is estimated to be lower at Rs 4 billion as at March 31, 2003, as compared to over Rs 5 billion as at March 31, 2002.

Besides, Telco’s short-term credit risk profile derives comfort from its relatively low debt repayment obligations of Rs 3.70 billion over the next two years in relation to its anticipated cash accruals. The possibility of a further divestment of a part of the company’s remaining non-core asset portfolio also provides additional cushion to its financial flexibility.

Group support continues to enhance financial flexibility: Telco’s ratings continue to derive comfort from the support provided by the Tata group. This is the largest and most diversified business group in India and Telco is one of its flagship companies. The fact that the Tata group subscribed to more than its share of Telco’s rights issue in November 2001 underscores its commitment to the company.

Industry Outlook
Commercial vehicle demand is expected to be sluggish over the next two years with a likely decline in sales volumes in 2003-2004. This is in line with the industry’s trend of a year of strong growth followed by two years of decline in volumes or sluggish growth. Moreover, the large freight capacity created in the current year to meet the increased requirements on account of the Golden Quadrilateral highway project is likely to be partially released next year. This may impact incremental demand over the next two years. Telco’s commercial vehicle volumes too are expected to remain sluggish over the next two years in line with this industry trend.

The domestic passenger car market is expected to grow at around 8-10 per cent over the medium term. Although Telco has been able to strengthen its market position in the domestic passenger car segment, it will have to expand its portfolio with new variants and regularly refresh its existing models to withstand the intense competition arising from new model launches by foreign and domestic players.

The company’s profit performance will also be linked to its ability to achieve steady volumes of around 1200-1500 units for the Indigo and its success in expanding its export volumes. In the MUV business, Telco’s performance is expected to remain sub-par in the medium term. In the long-term, the company’s ability to expand its MUV volumes will be key to its performance. In sum, while Telco’s revenues and profitability in the passenger car and MUV segments are expected to improve over the medium term, the gains may be counter-balanced by higher product development costs.

Rating Sensitivity Factors
The key factors impacting Telco’s future credit risk profile are:

  • The company’s ability to sustain its current lean working capital structure.
  • Ability to achieve its targeted sales volumes of about 1500 units per month in the C segment of the passenger car market.
  • Ability to stick to its two-year capital expenditure plans of about Rs 13 billion.
  • Ability to sustain and improve the current break-even levels in both its businesses (under 70,000 units in commercial vehicles and a little over 100,000 units in the passenger car and MUV business).