Detailed Rationale

CRISIL Ratings has revised its outlook on the long-term bank facilities of Sarda Energy and Minerals Limited (SEML; part of the Sarda group) to ‘Positive’ from ‘Stable’, while reaffirming the rating at 'CRISIL A+’. The rating on the short-term bank loan facilities has been reaffirmed at 'CRISIL A1.'

 

The outlook revision reflects the expectation that the credit risk profile of SEML may improve, driven by superior operating efficiency supported by sector buoyancy and enhanced backward linkages aided by operationalisation of coal mines, which would enable SEML to meet the entire standalone coal requirement once it achieves full ramp-up. The operating efficiency continues to benefit from the integrated nature of operations, captive iron ore mines (meeting 40-50% of the requirement and captive power plant meeting the entire power requirement. Healthy cash accrual and expectation of no material cash outflow to the group companies shall result in further strengthening of the financial risk profile and thus will be a key monitorable.

 

High sales realisations seen across the steel industry boosted business performance of SEML in fiscal 2021 despite disruptions amid the Covid-19 pandemic and the performance is likely to remain strong this fiscal as well. Standalone operating income and operating profit grew by 12% and 55%, respectively, in fiscal 2021 and are likely to further rise in fiscal 2022, as evident from the first quarter results. Operating profitability should structurally improve over the medium term, supported by enhanced backward linkages leading to cost saving, ensuring healthy cash generation. Operating performance of the subsidiary of SEML, Sarda Metals and Alloys Ltd (SMAL; CRISIL BBB+/Positive/CRISIL A2), also improved in fiscal 2021 and is expected to remain healthy over the medium term, as seen in the performance for June 2021 quarter. Furthermore, the ongoing capital expenditure (capex) for setting up of a third furnace would result in improved cost efficiency for SMAL and, in turn higher margin on sustainable basis going forward.

 

Improved profitability has led to healthy debt protection metrics, as evident from interest coverage ratio of 7.7 times in fiscal 2021 compared with 4.8 times in the previous fiscal, expected to remain above 10 times over the medium term. Liquidity has improved, backed by low utilisation of the fund-based working capital limit and steady cash accrual. CRISIL Ratings has also noted the group’s large hydro power project under Madhya Bharat Power Corporation Ltd (MBPCL) achieving commercial operation as on June 30, 2021, which in turn would improve liquidity at the overall group level.

 

The ratings continue to reflect the group's established market position, supported by diversified revenue streams and integrated nature of operations and a healthy financial risk profile. These strengths are partially offset by exposure to risks related to the cyclical nature of the steel and ferroalloy industry and large investment in associate entities.

Analytical Approach

CRISIL Ratings has combined the business and financial risk profiles of SEML and SMAL, together referred to as the Sarda group. SMAL is a wholly owned subsidiary of SEML, and both are engaged in similar businesses. Furthermore, SEML has guaranteed Rs 52 crore of the debt of SMAL as on March 31, 2021, and has provided support to the latter through unsecured loans in the past. CRISIL Ratings has also moderately consolidated the subsidiaries MBPCL and Chhattisgarh Hydro Power LLP (CHP LLP), in case any fund infusion in these entities may be required from SEML to support projects over the medium term as seen in the past. The remaining subsidiaries, joint ventures and controlled entities are treated as financial investments.

 

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

Key Rating Drivers & Detailed Description

Strengths

• Established market position: The group is one of the largest manufacturers of manganese-based ferroalloys in India and caters to the domestic as well as global markets. This is supported by the extensive experience of the promoters and a qualified management. Revenue is diversified across sale of intermediate and finished steel products, ferroalloys and surplus power from the captive power plant. The product mix is backed by the ability to manufacture different grades of steel products and niche-grade manganese-based ferroalloy products.

 

• Integrated nature of operations: Operations are backward integrated with a captive iron ore mine that meets 40-50% of the total iron ore requirement and a captive power plant that meets 100% of the total power requirement, leading to high operational efficiency. Integration has further improved after securing coal mines adequate for the entire captive consumption once the mine ramps up fully. Surplus power generated is sold to state distribution companies or traded on the Indian Energy Exchange. Flexibility of changing the revenue mix within intermediate steel products and final products as well as power sales help in successfully manoeuvring business cycles and sustaining the operating margin. Bulk procurement of raw materials for the group saves raw material cost. Similarly, proximity of SMAL to the Vishakhapatnam port in Andhra Pradesh saves logistics cost and helps target global markets. This resulted in a stable and healthy operating margin of around 14% even during the downturn in fiscal 2016.

 

• Healthy financial risk profile: Debt protection metrics were healthy, indicated by interest coverage and net cash accrual to total debt ratios of 7.7 times and 0.53 time, respectively, in fiscal 2021. The capital structure is strong, with gearing at 0.35 time as on March 31, 2021. The financial risk profile is expected to strengthen further despite planned capex largely towards coal mines ramping up (funded through internal sources), driven by healthy cash accrual.

 

Weaknesses

• Exposure to cyclicality in the steel and ferroalloy industry: The industry is closely linked to the domestic and global economy, as growth depends upon the level of construction and infrastructure activities. Any downturn in the economic cycle adversely impacts demand, as seen in fiscal 2016. Furthermore, any changes in government policies on imports/exports affect the industry; exports contribute 20-30% to the group's revenue. In addition to the demand risk, the industry remains exposed to volatility in raw material prices and finished product realisations, which can impact the operating margin. The prices are largely subject to global commodity prices. However, this is partially offset by the integrated nature of operations, flexibility in changing the revenue mix between steel and steel intermediates, ferroalloys and power, and ability to pass through the change in raw material prices to customers. Any significant variation in the demand and pricing scenario will remain a key monitorable.

 

• Significant investment in associate entities: Equity investments in subsidiaries (excluding SMAL), joint ventures and controlled entities were around Rs 608 crore (29% of the tangible networth) as on March 31, 2021. The investments are largely in unrelated businesses (such as hydro power) and in entities with weaker credit risk profiles as well as back-ended returns. Time and cost overruns in MBPCL have constrained the return on investment. Furthermore, support may be required in MBPCL for the stabilisation period of the project. Slower-than-expected plough-back of advances from the group companies will remain a key rating sensitivity factor.

Liquidity: Strong

The group’s net cash accrual is expected at over Rs 500 crore in fiscal 2022 against maturing debt of Rs 76 crore. Net cash accrual is adequate even after factoring in the capex, largely towards commissioning of coal block mines. Bank limit utilisation averaged 8% over the 12 months through June 2021. Cash and equivalents stood at around Rs 101 crore as on August 31, 2021, thus supporting liquidity.

Outlook: Positive

Operating performance is likely to improve because of the expectation of improved operating efficiency resulting in a stronger financial position.

Rating Sensitivity factors

Upward factors

• Net cash accrual higher than Rs 550 crore on a sustained basis
• Liquidity improving on account of reduced exposure to related entities or maintenance of higher cash surplus on balance sheet

 

Downward factors

• Net cash accrual of less than Rs 250 crore on a sustained basis
• Exposure (equity/loans and advances) to group companies (excluding SMAL) increasing beyond 30% of the tangible networth
• Large, debt funded capex or acquisition weakening the debt protection metrics and liquidity

About the Company

Based in Chhattisgarh, the Sarda group is promoted by Mr Kamal Kishore Sarda, who manages operations along with his son, Mr Pankaj Sarda, with the help of professionals. It manufactures iron pellets, sponge iron, billets, wire rods, and wires, along with ferroalloys and eco- friendly fly ash brick. The group has thermal power plants and a waste-heat recovery boiler to generate power that is largely used for captive consumption.

 
SEML, incorporated in 1973, is the flagship company of the group. It is a vertically integrated producer of steel with captive iron ore and coal mines. It also manufactures and exports niche-grade manganese-based ferroalloys, with self-sufficient captive power from waste heat and coal.

 

SMAL, incorporated in October 2008, is a wholly owned subsidiary of SEML and operates a 2x33-megavolt ampere ferroalloy plant, backed by an 80-megawatt captive thermal power plant. The group also has interests in hydropower projects through special project vehicles, MBPCL, CHP LLP and Parvatiya Power Ltd.

 

For the quarter through June 2021, on a standalone basis, SEML had PAT of Rs 134 crore on total revenue of Rs 619 crore against PAT of Rs 23 crore on total revenue of Rs 231 crore in the corresponding period of the previous fiscal.

Any other information: Not applicable