Detailed Rationale

CRISIL Ratings has assigned its ‘CRISIL A1+’ rating to the commercial paper programme of Megha Engineering and Infrastructures Limited (MEIL).

 

The rating is driven by MEIL’s strong and established market position in the Engineering, Procurement and Construction (EPC) business with a track record in executing complex and large projects along with improved diversity in its large order book size, which provides healthy revenue visibility over the medium term. It also factors in the company’s healthy operating efficiency and its minimal dependence on external debt which has resulted in comfortable financial risk profile. ThThese strengths are partially offset by the investments made by MEIL in unrelated businesses and group companies, susceptibility to intense competition and cyclicality in the infrastructure and construction industry and large working capital requirement.

 

MEIL has established strong and diversified position in the EPC business with presence in more than 15 states. MEIL is the second largest EPC player and has a track record of successfully implementing prestigious projects across segments such as irrigation, roads, drinking water, hydrocarbons etc. Few of its marquee projects include the Assam Renewal Project, Pattisam Project, Kaleshwaram lift irrigation project and Zojila Tunnel etc. Over the years, the company has witnessed significant improvement in scale of operations owing to its strong execution capabilities, with revenues registering compound annual growth rate (CAGR) of 24% to Rs 21918 crore in fiscal 2021, from Rs 6282 crore in fiscal 2015.

 

Revenue visibility remains healthy over the medium term with a strong order book position of Rs 1.3 lakh crore as on October 31, 2021, an increase of more than 50% over the last three years. The bill to book ratio has remained at 3.5-4.5 times over the last few years and has increased to 6.3 times in fiscal 2021. MEIL has improved the diversity in its order book over the last five years. The proportion of irrigation and drinking water projects has reduced to ~55% currently from 70-80% earlier, while share of orders from states of Andhra Pradesh and Telangana has reduced to ~50% in the current fiscal from ~60-70% in fiscal 2015. Over the medium term, hydrocarbons will be the new focus area for the company under the EPC segment which is also reflected in increasing share of hydrocarbons in overall orders received to 43%, in fiscal 2022, compared with 2% of orders received in fiscal 2021. 

 

MEIL has made investments in diversifying its business presence into new segments such as electric vehicle (EV), EV bus operator, City Gas Distribution (CGD) through its subsidiaries and group companies. The Company has showcased its ability to successfully turnaround and ramp up operations of past acquisitions including  ICOMM Tele Ltd and Italy based companies Drillmec SPA and Petreven SPA. Furthermore, key assets such as Western U. P. Power Transmission Company Limited (WUPPTCL) is generating healthy accruals post commissioning and has reduced advances and receivables to MEIL over last two fiscals. Similarly, with commissioning of SEPC Power Limited (SEPC) in current fiscal, the asset is likely to generate healthy cash flows.

 

The company is expected to pursue its aggressive acquisition led growth strategy over the medium term. MEIL has plans of bidding for public sector units. The quantum and funding mix of acquisitions undertaken by the company will remain key rating sensitivity factors.

 

Furthermore, MEIL enjoys healthy operating capabilities. The company has sustained operating margins at 16-18% over the past years as a result of backward integration and efficient working capital management. Over the medium term, the operating margin is expected to improve to 18-19%.  Along with efficient working capital management, the cash flows will be supported by healthy performance of past investments made in entities WUPPTCL), SEPC and Olectra Greentech Ltd. The performance of these key entities will remain a key monitorable.

 

The financial risk profile of MEIL is comfortable with well capitalized balance sheet and strong debt protection metrics. Despite large investments, the reliance on external debt for the company remained limited resulting in gearing of 0.18 time as on March 31, 2021. The momentum in capex and investments made by the company are likely to continue over the medium term. Capex in EPC business is expected at Rs 1000-1500 crore per annum over the medium term, apart from investments/ acquisitions planned by the company. Despite this, the debt protection metrics are expected to remain healthy with interest coverage of more than 6 times, net cash accruals to total debt (NCA/TD) of above 50% and total outside liabilities to tangible net worth (TOL/TNW) ratio remaining at 1-1.2 time.

 

MEIL is expected to generate annual cash accruals of Rs 3500-4000 crore which would be sufficient to take care of long-term annual debt obligations of Rs 200-300 crore and fund capex and incremental working capital requirements. The liquidity profile of MEIL is supported by healthy cash surplus of almost Rs.4000 crores. Though, MEIL keeps part of the surplus as margin against the non-fund-based limits, the unencumbered cash surplus was at Rs 1937 crore in March 2021 and is expected to remain in the vicinity of Rs 2000 crore over the medium term. It is likely to be used as a liquidity back-up for commercial paper issuance, if any, by the company. Ability to sustain significant unencumbered cash surplus will remain a key rating sensitivity factor

 

Bank limit utilization of the fund-based facilities of Rs 318 crore remain low at 15% while non-fund-based utilization remains at 92% on average over the last 15 months through October 2021. Enhancement in the non-fund-based limits to support growth will be critical to ensure uninterrupted execution by MEIL.

Analytical Approach

CRISIL Ratings has considered the consolidated financials to arrive at the rating for MEIL factoring in its subsidiaries WUPPTCL and SEPC in India and overseas on account of strong business and financial linkages including fungible cash flow between these companies. CRISIL Ratings has also consolidated Olectra Greentech Ltd (wherein its stake increased to 50% as of September 2021) from fiscal 2022 onwards. The company also has four hybrid annuity model (HAM) road projects, under special purpose vehicles (SPVs). CRISIL Ratings has factored in equity infusion in these SPVs to the extent of MEIL's shareholding and factoring in possible cost overruns. However, MEIL has not guaranteed the debt in these SPVs.

 

Please refer Annexure - List of entities consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths:

Strong market position with track record of executing complex and large projects

MEIL is the second-largest EPC player in terms of revenue and the largest EPC player in irrigation and drinking water works in India. MEIL has shown ability to diversify to several sectors such as hydrocarbons, roads, power, buildings, railways etc. The business spans a spectrum of projects, ranging from complex turnkey EPC projects to simple construction activities. In-house design, engineering and fabrication capabilities for critical equipment and systems give a strong competitive advantage. Strong competencies across segments and sectors along with a track record of completing projects as per specifications have led to a robust brand image in India.

 

MEIL has established relationships with various state government departments by virtue of its track record of over two decades in the construction industry and timely project execution. The company mainly bids for projects floated by various government bodies. The company has a fleet of construction equipment, which enables it to bid competitively for several projects.

 

The strong project execution capability is reflected in successful completion of projects within the scheduled time and budgeted cost. The strong in-house EPC division undertakes all project implementation. Over the past decade, MEIL leading position in the domestic EPC segment is supported by executing complex and large projects including prestigious projects such as WUPPTCL, Kaleshwaram Lift Irrigation Project, Polavaram project, Assam Refinery project and the ongoing Zojila tunnel project amongst others. As a result, the consolidated revenue has grown at a five-year CAGR of ~24% to around Rs 22000 crore in fiscal 2021.The company also has undertaken projects in several countries such as Kuwait, Tanzania, Jordan, Zambia, and Rwanda.

 

Improving diversity in revenue and order book

The revenue visibility of the group is strong backed by healthy outstanding order book of ~Rs 1.3 lakh crore as on October 31, 2021 with 55% of the orders pertaining to irrigation and drinking water segments. The company has received orders of Rs 32150 crore upto 31.10.2021 in fiscal 2022 led by hydrocarbons (~43%), irrigation and drinking water (42%) and the rest from power and building segment.

 

Majority of the outstanding orders are from domestic projects with reducing share of its earlier focused States of Andhra Pradesh and Telangana in outstanding order book from ~70% in past fiscals to ~50% in current fiscal. This reflects diversification of revenue across segments and states in India, majorly on account of the company’s continuous focus on increasing its presence across the country. 

 

Similarly, MEIL had been focusing on diversifying its order book across various segments along with maintaining its position as a market leader in irrigation and drinking water segments. At the end of October 2021, 55% of the overall order book comprised of irrigation projects compared to 82% in fiscal 2018. In the current fiscal, MEIL derived ~43% of the overall new order from the hydrocarbon sector, thus demonstrating its increased focus to reduce geographical and segmental concentration.

 

Going ahead, the order book is expected to grow 10-12% and overall revenue growth would be driven by hydrocarbons which is expected to be the new focus area for MEIL under EPC segment. CRISIL Ratings expects MEIL will register healthy double digit revenue growth over the medium term.

 

Healthy operating efficiency supported by backward integrated operations

On a consolidated basis, MEIL’s operating margin has sustained at 16-18% since fiscal 2016. The company has set up backward integration facilities for engineering and fabrication capabilities for critical equipment and systems including manufacturing different types of pipes and pressure vessel division. This has helped in sustenance of stable operating margins in the last five fiscals despite competitive pressure. Similarly, MEIL is focused on reducing subcontracting expenses and hedging price of commodities such as steel by entering long-term contracts with large steel manufacturers with price variation clauses for a major portion of its order book.

 

Over the medium term, the focus will be on hydrocarbon projects which have higher margin and lower working capital requirement compared to irrigation projects. This will result in better overall operating profitability for MEIL over the medium term.

 

Comfortable financial risk profile

MEIL’s financial risk profile is comfortable, supported by sizeable net worth of Rs 15,674 crore as on March 31, 2021 which is expected to improve to above ~Rs 18000 crore in fiscal 2022. MEIL’s strong cash generating ability, supported by healthy profitability, has ensured low debt requirement, despite sizeable investments in diverse business segments and capex. MEIL has undertaken capex of Rs 4648 crore (including acquisitions) since fiscal 2019 and investments were Rs 1126 crore in fiscal 2021.

 

Debt protection metrics were healthy - gearing and TOL/TNW ratio were at 0.18 time and 1.08 times respectively as on March 31, 2021 and estimated at 0.19 time and 0.96 time respectively in fiscal 2022. While interest coverage and NCA/TD rations were ~7 times and 0.89 time respectively in fiscal 2021. It is expected to be 6.18 times and 0.83 time respectively in fiscal 2022.

 

MEIL intends to finance its four HAM projects largely through internal accruals. The company is expected to invest Rs 3000-4000 crore in fiscal 2023 for inorganic expansion, which will involve part debt funding. Total debt is likely to increase from Rs 2850 crore in fiscal 2021 to Rs 6000-7000 crore over the medium term at consolidated level.  However, due to strong annual cash generation of ~Rs.3500-4000 crores, the debt protection metrics will remain healthy over the medium term - Interest coverage ratio is expected to be  more than 6 times, NCATD at above 0.50 times, and TOL/TNW ratio being range bound at 1-1.2 times.

 

Some of the past major investments of MEIL such as WUPPTCL and SEPC are expected to witness healthy performance over the medium term which would support the overall cash flows of MEIL. The company may explore option to monetise the HAM assets through InvIT or avail debt by escrowing these cash flows based on requirement. On a similar construct, MEIL may escrow WUPPTCL’s cash flows and avail bank loan to effectively manage its liquidity. CRISIL Ratings believes MEIL will maintain at least Rs 2000 crore unencumbered cash in the form of fixed deposits, mutual funds and utilization of fund-based limit to remain minimal.

 

Weaknesses

Investments in unrelated businesses and group companies

MEIL has a complex structure with more than 35 subsidiaries, 4 SPVs and other associate concerns.  MEIL has been venturing into new businesses such as EVs, EV bus operations and city gas distribution, which compared with existing EPC business require separate set of skills. Though MEIL has showcased ability to take diverse projects in the past within the EPC segment, different from its core capability of undertaking irrigation and drinking water projects, the new business is outside the EPC purview. The successful implementation and performance of these businesses would be critical, to ensure limited drain on the resources generated by MEIL. The Company has also expressed intent to participate in bidding for PSU organizations such as Shipping Corporation, Bharat Earth Mover Ltd etc. and suitable assets via IBC route.

 

The company has divested its stake in its distressed loss-making assets- HKR Roadways Pvt Ltd and Nagai Thermal Power Project, in the current fiscal. Both entities are no longer associated with the MEIL group. As a result, its negative impact on cost of borrowings or credit profile of MEIL is expected to reduce resulting in cost savings.

 

Currently, the investments in group companies during fiscal 2021 are at 8.1% of the consolidated net worth. Some of these investments such as WUPPTCL have started generating healthy return on capital employed however on combined basis return on these investments remained low. Any substantial increase in investments in group companies constraining return metrics would be a key monitorable.

 

Susceptibility to intense competition and cyclicality in the construction industry

MEIL is exposed to cyclicality inherent in the EPC industry and volatility in profitability amid intense competition in the EPC segment.

 

Of the order pipeline as of October 2021, the irrigation and drinking water accounted for 55% and the remaining were from the other infrastructure segment. With the increasing focus of the central government on the infrastructure sector, MEIL is expected to reap benefits over the medium term. However, most of its projects are tender-based and face intense competition, which may require it to bid aggressively to get contracts. Also, given the cyclicality inherent in the EPC industry, the ability to maintain profitability margin through operating efficiency becomes critical.

 

Working capital intensive operations

The working capital requirement is inherently high in the EPC industry, given the dependence on state and central government authorities for timely receipt of payments. The gross current assets (GCAs) were high at 213 days mainly due to high debtors of 118 days as on March 31, 2021. Debtors are largely in form of receivables and retention money from ongoing and past projects which are expected to come down gradually. Other current assets including advances to sub-contractors and encumbered cash are increasing over last few years and hence the GCA have been 150 to 230 days over the last five years. MEIL has been funding this through large advances which has remained 25% of the overall gross current liabilities.

 

Going ahead, the management’s intention to focus on collection and judicious bidding for new projects with lower working capital intensity should keep the overall working capital requirements under control. With this, GCAs are expected to decline gradually over the medium term.

Liquidity: Strong

Liquidity is supported by healthy cash accruals, unutilised bank lines, and sizeable cash surpluses. Cash accrual is expected to remain at Rs 3500-4000 crore, which is sufficient to service annual maturing debt obligation of Rs 200-300 crore over fiscals 2022 and 2024 and meet the company’s capex and incremental working capital requirement. Fund-based bank limit of Rs 318 crore was utilised at 15% on average and non-fund-based facilities were utilised at 92% on average over the 15 months through October 2021. MEIL is in further discussion with the lenders to tie up the working capital limits, majorly bank guarantees and letter of credits, to ensure its project execution profile is not disrupted. Timely sanction of the limits will be critical.

 

With focus on debtors, and modest investments, cash balance improved from Rs 1543 crore in fiscal 2017 to Rs 4746 crore in fiscal 2021 (of this unencumbered position was Rs 1937 crore). In the last five years, free cash as a percentage of revenue remained in the range of 8-10%. Going forward, the company is expected to maintain free cash surplus of Rs 2000 crore and utilization of fund-based limit is expected to remain minimal supported by healthy cash accruals and focus on efficient working capital management.

Rating Sensitivity Factors

Upward factors

• Successful implementation of group restructuring leading to simplification of group structure, segregation of EPC and unrelated businesses resulting in improved governance
• Sustained increased in scale of operations supported by steady order execution and sustenance of operating profitability at over 18-20%, leading to healthy cash generation
• Maintenance of healthy financial risk profile with TOL/TNW ratio below 0.7-0.9 times and healthy cash surplus through prudent management of the working capital.

Downward factors

• Weak order execution, impacting revenue booking and operating profitability (below 10-12%), and cash generation.
• Higher than anticipated scale of acquisitions, exposure to group companies, unrelated businesses or sharp increase in GCA days to 240-250 days leading to increase in debt levels, impacting debt metrics (TOL/TNW ratio more than 1.6-1.8 times).
• Steep decline in liquid unencumbered cash surpluses, or non-maintenance of liquidity back-stop for the issuance of commercial paper.

About the Company

MEIL is a major EPC and infrastructure company headquartered in Hyderabad, India. The company was established in 1989 as a small fabrication unit. Over the years, the company has diversified across verticals and undertakes turnkey projects related to irrigation, urban water supply, hydrocarbon, transport, power, and roads. It also manufactures mild steel and spiral pipes as well as customized fabrication as a backward integration initiative.

 

MEIL has presence in more than 17 states in India and 20 other countries. The company derives 95% of revenue from the EPC segment.

 

In first seven months of fiscal 2022, MEIL (on a standalone basis) posted revenues of Rs 14711 crore against profit after tax (PAT) of Rs 1715 crore.

Any other information: Not applicable