Elgi Equipments Limited (ELGIEQUIP) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to the Elgi Equipments Limited Q3 FY '20 Earnings Conference Call hosted by Asian Markets Securities Private Limited. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Kamlesh Kotak from Asian Market Securities. Thank you, and over to you, sir.

Thanks, Nirav. Good evening, everyone. On behalf of Asian Markets, we welcome you all to the 3Q FY '20 earnings conference call of Elgi Equipments Limited. We have with us today, Mr. Jairam Varadaraj, Managing Director, representing the company. I request Mr. Jairam to take us through an overview of the company's performance and the results, and then we shall begin the Q&A session. Over to you, sir.

Thank you, Kamlesh. Thank you for organizing this call. Ladies and gentlemen, it's my pleasure to be with you this evening. I will take you through the performance of the company in this quarter in comparison with the quarter of the prior year. I know the results look -- on paper, they look quite gloomy, but I'm sure that with my explanation at the end you will realize that the story is not so bad. And I'll take you through the reconciliation of the EBITDA between this quarter and the prior year quarter. Starting with sales. We did INR 463 crores at a consolidated level as opposed to about INR 470 crores last year. Against a contribution margin of 39.4%, we have improved it to 40.6%. So taking these 2 sales numbers, the EBITDA, assuming fixed cost and the people cost are at the same level as last year, our EBITDA should have been about INR 530 million -- INR 51 crores; against that, it's approximately INR 30 crores. So I'm going to take you through a reconciliation for almost this INR 22 crores of reduction in EBITDA. So the biggest cost that has hit on our EBITDA is people cost, and I would like to dissect the people cost and explain to you. Out of the total people cost, as you know, as I've explained in my past calls, we have embarked on a strategic initiative in Europe. Towards that, we have been building our team in Europe. I would like to now step back and give you a little bit of visibility into what our initiative in Europe is. We are going through an organic growth model in Europe. Our plan is to add close to 70 people to our team in Europe, and we are entering all the markets in Europe except Germany. And towards that end, over a 3-year period, including -- starting from '20-'21, including this year, '20-'21, '21-'22 and '22-'23, our loss that we expect out of Europe is close to about EUR 20 million, that converts to about INR 160 crores. Now against this investment -- I call this loss on investment. Against this investment of EUR 20 million, approximately INR 160 crores, we expect a top line in the fifth year of close to about EUR 75 million or close to EUR 80 million. Now if I look at this growth and compare it with an opportunity which is inorganic for an EUR 80 million inorganic opportunity, at the current valuation, roughly similar to what we did for Michigan Air, the price that we would have had to pay would be about close to -- anywhere between EUR 60 million to EUR 80 million. Now against that, our investment is going to be EUR 20 million. And in the fifth year -- by the end of the fifth year, we would have recovered this investment. And this plan has been done with high levels of diligence right down to each market at each distribution level. So therefore, we are reasonably confident considering the success that we have had in Italy that we will be able to execute on this plan. So this is the context of our larger European plan. We'll talk about this later. Now if I funnel that plan into the Q3 results, we have had close to EUR 55 million in people cost, which is additional specific for the European project, the initiative in Europe. In addition to this EUR 55 million, we have had close to about EUR 100 million of additional people cost, and this has been primarily one of the biggest challenges -- biggest investments in people has been in India to the extent of almost 35 million. And this we did last year in anticipation of a continued growth of the economy. We have already started working towards rationalizing these costs, and I'm very confident that in '20-'21 you won't see this -- I don't anticipate these costs to be continuing on the same trajectory for '20-'21. But this is an investment we made anticipating that we will be growing India to the extent of almost 18%, but what has actually happened is a degrowth to the extent of between 4% to 7%. So again, this is an unforeseen expense which we will get back on the track. Other than India, we've had some investment increase in cost in the U.S. and in Italy, but these are not significant in relation to the performance of these units. So I'm not too concerned about that. The other reconciliation is the other fixed cost. And in Belgium, as part of our recruitment of our talent and getting the talent on board, whether it is headhunter cost and all that, it has been close to about 30 million, which is going to go away, it is not going to repeat itself. On a regular basis, we have had some onetime expenses, and I'd like to focus on 2. One, in the U.S., we had a plan to sell our Patton's property for close to about 9 million, and we were looking to acquiring a smaller facility for about 4 million. We had signed the agreement for the sale of that property, but unfortunately, when the buyer went for approval for a building, they found that the wastewater capacity of this particular property was not adequate, and the city of Charlotte is working on improving the -- increasing the wastewater capacity and, therefore, the buyer backed out. But in the meantime, our plan to buy the new facilities, we had gone ahead and we had paid a deposit which we had to write off because we had to -- that it went into an escrow and we had to give up on escrow. That was to the extent of about 15 million. The other piece is, we had a bad situation in the Middle East where we had sold machines against postdated checks, and we realized subsequently when we deposited the checks that the buyer was actually -- was a criminal-minded person who had done this -- done it to not only Elgi and to quite a few other equipment vendors where he was buying equipment and selling them off and now he's absconding from the UAE. He's an Indian national based out of the UAE. So these 2 costs are close to about 27 million that are onetime that have hit us in this particular quarter. So if I normalize for all these costs, except for the strategic costs in Belgium, which is to the extent of about both people cost and fixed cost, which is about EUR 85 million, we are -- our profitability has been pretty healthy in spite of challenges in India. So this is a broad reconciliation, and I will rely on your questions to get into specific responses. Stepping back, to give you an overall context of where the markets are, I will -- like always, I will start in Australia. The Australian market and our growth has been pretty positive. In spite of the fires in Australia, we continued to -- the requirements, the inquiries and the orders have continued to remain, and the team's expectation is that we will have a good year in Australia. Southeast Asia has been a challenge. Specifically, I'm looking at Indonesia and Thailand. We have not done as per our budget. We have had marginal growth. So at the end of the year, we will not be meeting our budgets there, but we will end up slightly better than where we were last year. India has been a challenge, significant challenge across almost all the verticals. The inquiries which in the -- if I -- like in the third quarter when I talked about the performance in the second quarter, I had said that inquiries continue to be there, but the finalizations are getting delayed. But right now, the inquiry itself has become a little less. So we are not very -- we are not able to interpret the economy and now with the new budget, we don't know the consequences. So we are taking a very cautious approach in India. We still remain optimistic in terms of the market opportunity. We are looking inside rather than outside for how to leverage the opportunities that we have not tapped in the Indian market. And we see some potential, which we are going to look and leverage and deliver on for next year. So overall, for next year -- I would say this year India is a bit of a wash, but we have already started working on preparing to strengthen ourselves for next year. So I'm reasonably optimistic for the top line for India next year. But in terms of our cost management, the lesson that we have learnt is not to put cost upfront on the basis of an optimistic top line. We are not going to do that. Even though we have an optimistic top line view for next year for India, our cost management is going to be very tight on the basis that India is going to be flat next year as well. Middle East, barring this -- these onetime problems, the debt that we -- bad debt that we had, has had a good growth in the top line, and we are on track for our plans where we went direct in Middle East about 1.5 years ago, and our top line is beginning to support that strategy. Moving on to Europe. I will talk about Rotair in the context of the U.S. because there is a link there. Europe, on our industrial side, continues to do well. We have grown in Italy this year as well, and we are beginning to see green shoots coming in. Even with that little team that we have built, the smaller team, not the full complement of the team, whatever team we have built in Europe, we are beginning to see some very strong order books that are beginning to happen. Moving on to the U.S. Patton’s has grown compared to last year, but it's not done as per budget. But we are seeing the BCG project initiatives that we have done in Patton's, the reorganization that we have done, we're beginning to see very solid traction in the market. And I'm looking forward to Patton’s doing high levels of optimism. And the same thing I can say about Elgi Industrial outside of the Patton’s area. Patton's Medical was a huge challenge for us. There has been a significant drop in the revenue compared to last year. And this is -- can be attributed to 2 facts. One, we had -- one of our key distributors was acquired by a competitor, so we lost a big account there. And one of our key sales representative had a medical issue. And because of these 2 reasons, we lost a little bit of traction in the market. We have taken onboard 2 strong sales resources with industry experience. So I expect Patton’s Medical to come back to the levels that they should be in terms of the potential. Brazil continues to be a challenge. In spite of that, we have grown marginally, and we have grown profitably. The -- earlier, the subsidiary was making a loss. The losses have been stopped, and we are also looking at generating cash in the subsidiary. But I'm not going to celebrate that too early because the economy is still kind of a little uncertain. But there are -- there seem to be some green shoots in the economy. So this is really the summary of our business across the world. In terms of -- yes, I will -- I've got some more points that I will talk, but I think there will be questions that will cover those points. If they don't, then at the end of the call I will come back and talk about them. So thank you again. So I look forward to your questions.

[Operator Instructions] The first question is from the line of Ravi Swaminathan from Spark Capital.

Sir, just had 1 question. Regarding the Michigan acquisition, can you give some more color on and what is the strategy behind that? What is the thought process behind acquiring the Michigan entity?

Yes. Okay. If you remember, in my past calls, we said one of our strategic focus areas is the U.S., and within that, we said inorganic strategy as part in our global thing is to look at organizations that will give us access to customers, which basically meant distribution and service companies. So Michigan Air was -- and we also as part of our BCG project in the U.S., we identified the top metropolitan areas that we should focus on. And right now, our strategic focus is on the top 20. And Michigan, or the Detroit served area, is in the top 5. So as part of developing 1 of the top 5 market segments -- geographical segments in the U.S., we had -- we have already been in touch with Michigan Air and they were already distributing our products for the last 1.5 years. And they had -- we had an opportunity to acquire them because they were wanting to -- the owner was wanting to exit the business. And there was a very strong strategic fit because it was -- it belonged to the geographical area which is in the top 5. It was already distributing our product, the people were conversant with our products, our people knew all of their people, the cultural and social fit of the organization was very good and, therefore, we have -- we acquired the company. And so that's the logic behind the acquisition of Michigan Air.

Okay. And Michigan covers the northern part of U.S.A. and Patton's covers the southern part of U.S.A. That is also an intention? I mean for basically, geographically...

No. No, no. See, Michigan Air has 2 branches, 1 in Grand Rapids and 1 in Detroit. So if you look at the State of Michigan, there is the lower peninsula and the upper peninsula. Bulk of the economic activity is in the lower peninsula. So Michigan Air, by virtue of these 2 branches, will be able to cover the primary economic activity of the State of Michigan, which is the lower peninsula of Michigan. As opposed to that, Patton’s has 7 branches and they cover 4 states. So Patton’s has a much larger territory. So it's not like Michigan Air is going to expand beyond Michigan.

Okay. Got it, sir. And my last question is, so basically, regarding the employee cost, you had given a detailed breakup, but 1 doubt regarding the Europe employee cost. So basically, you had mentioned that over the next 3 years, we would be spending INR 150 crores, right? I mean with respect to employee cost alone or is it total fixed cost?

It is -- no, no, no. It is the loss of the operation which includes employee cost, fixed cost, other fixed cost after the sales that we plan to do for the first 3 years.

Okay. Okay. So this cost would remain, but sales would pick up after the third year. And -- I mean gradually from next year's...

Sales is already coming in as we speak, Ravi. It is going to reach a point at the end of the third year, we will break even, right? So on the fourth and fifth year, we will be able to recover the cost.

Got it, sir. And how much amount of that -- I mean in this quarter, how much amount of that loss -- fixed cost related to Europe is there embedded in the numbers, roughly?

Well, the sales is hardly anything. So if you take the people cost and the fixed -- and the other fixed cost that I was talking about, close to about EUR 85 million is sitting as a cost due to the loss of the operations of Elgi Europe.

[Operator Instructions] Next question is from the line of Renjith Sivaram from ICICI Securities.

Sir, just a small -- when we listen to Cummins call, they had shown growth in the compressor segment under their industrials. That means the compressor engines that they sell to compressor manufacturers. So why we are showing a disconnect while they are showing a growth in the engine? So what explains that variance?

See, there are 2 aspects to this. One is the -- see, our market share in the water well segment is not as strong as it used to be. So we've lost market share, and this is something that I acknowledged about 3, 4 years ago, and we are in the process of building that share over a period of time. To that extent, the growth in our water well business is not as strong as what the total engine sales that Cummins has got. The second part of the story is, there is a certain amount of inventory that is sitting -- engine inventory that is sitting, so we have to see what is the result on a longer time frame, whether that pattern is being sustained by Cummins. Now we have initiatives in the water well segment even as we speak. But my optimism to get that share back in a very short time is not very high, but we -- I'm optimistic that we have some very strong programs to recover it. So to answer your question, the gap between the sales growth that Cummins has projected for the compressor segment and our inability to deliver growth in that segment that uses those engines is partly because we have lost our share in that market. The competitor is definitely stronger than us. And partly, it is also there is a buildup of inventory.

And is this competitor inorganic or you see a strong organic competitor trying to gain foothold in this market?

I don't understand what you mean by inorganic competitor.

Sorry, not inorganic. Is it kind of what do you call non -- unorganized...

No, no, no. This is all -- these are all organized players. These are all large machines used in water well segment. So these are organized players.

Okay. And that means that there is -- they have tried to reduce the prices and increased the price competition?

No, no, no. So this market behaves on the basis of opinion leaders by a machine then everyone follows. We used to be a dominant player. At that time, the opinion leaders favored Elgi and everyone kind of worked with Elgi. We had a bit of an issue about 4 years ago with 1 of our machines. And at the same time, the competitor had -- was able to grab our share of the market, and the market is staying with the competitor on the basis of inertia. So we need to break that inertia with a value proposition that is compellingly strong so that we can change the opinion leaders and, therefore, move the momentum of the market from inertia towards Elgi -- towards momentum for Elgi. So that's really the strategy we're working on.

Okay. And sir, we hear a lot of investment from the government was the road sector. So road construction uses a lot of compressors. So are you not excited regarding those investment outlook?

So you'll have to wind back to the financial year '18-'19 when we had a good growth, if you look at our numbers, and that was on the back -- both '17-'18, '18-'19, that was on the back of large amount of roads that were being built and the Ministry was really talking about how many -- so many kilometers of -- per day of roads being built in the country. At that time, there was a huge increase in the demand for our products from the construction primarily the Construction segment involved in road building. Now what is apparent and what we are hearing is 2 things. One, the -- most of the customers who buy our compressors for this particular industry vertical are contractors who are -- who get these contracts from the people who bid for building the roads. Now these contractors will -- so one is there is high levels of stickiness in the payment that is due to all these contractors who got these tenders from the government, their payments have become sluggish. And two, the financing, because these are all not bank finance, these are secondary and tertiary institutions that finance these contractors. Those financing options have kind of become a little dull. As a consequence, the demand overall is low. This budget has again talked about infrastructure and building it. We need to wait and see how much the back dues are paid out. Unless that liquidity gets back into the market, it will be difficult for contractors to bid for more tenders because how do they finance it? That is the problem.

[Operator Instructions] Next question is from the line of Manish Goyal from Enam Holdings Private Limited.

Sorry to harp again, just to clarify. So the number you mentioned about EUR 20 million operational loss, that is in the peak -- that will peak out into 2022 or it's a cumulative number?

It's a cumulative number from '20 -- from now onwards '20-'21, '21-'22, '22-'23. It's cumulative.

Okay. Cumulative number. And so ideally, like, say, on a yearly basis, if you can give a sense as to what could be the annual number, in a range, I'm not asking for exact number, but like if you want to put a number that -- is it that this loss number will peak in 2022? And what number likely it could be? Number one. And number two, you mentioned from the third year it breaks even. So ideally, we are talking about '22 and '23. So what kind of sales would you require to break even?

So our breakeven is going to happen at around 70 -- between EUR 70 million and EUR 75 million. Now our starting EBIT loss for '20-'21 is going to be about EUR 12 million. It will go up to EUR 18 million and then peak at EUR 20 million. So EUR 12 million, plus another EUR 6 million, plus another EUR 1 million. That comes to EUR 19 million to EUR 20 million at the end of the third year.

Okay. So this -- in FY '23, EUR 19 million loss will be the cumulative number you will reach?

Yes. FY '2023 -- sorry, '22-'23.

'22-'23. Fine, sir. But you also mentioned that you expect revenues of EUR 75 million to EUR 80 million in fifth year. So that will be ideally '24-'25?

Yes, '24-'25, we will break even, cumulatively. So '22-'23 will be the peak. After that, it will slide down, the cumulative losses. And the next 2 years after '22-'23, we will break even, cumulatively.

And if you can just share what could be the revenue number you are expecting in FY '21. So that gives us a complete perspective as to how...

Manish, I don't want to give up the entire business plan to the competitor. I'd be happy to...

Sorry, sir.