Elgi Equipments Limited (ELGIEQUIP) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to Elgi Equipments 2Q FY '21 Post Results Conference Call, hosted by Asian Market Securities 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, Sanvi. Good day, everyone. On behalf of Asian Market, we welcome you all to the 2Q and 1H FY '21 Earnings Conference Call of Elgi Equipments Limited. We have with us today Mr. Jairam Varadaraj, Managing Director, representing the company. I will request Mr. Jairam to take us through an overview of the quarterly and the half yearly results, and then we shall begin the Q&A session. Over to you, sir. Thank you.

Thank you, Kamlesh. Good evening, ladies and gentlemen. Thank you for your time this evening. I will -- as we normally do, I'll take you through the quarter results for the current year in comparison to the quarter results in the previous year. I will first talk about the financial numbers and then as we go into a business -- general business perspective, and then we will open it up for Q&A, and then we'll present what the outlooks are. Now if you look at our financial numbers, our sales have been higher than the previous year's second quarter by almost about 10% or roughly about 8-plus percent. Bulk of the sales increase has been the shift in the geography. International -- rest of the world revenue has moved from 45% last year to about 57% in the current quarter -- in current year's quarter. And if we really look at the international business, bulk of the growth has come from Europe, which is an initiative that we started a year ago, where we have created an organic growth model. We've built a team there, and that is beginning to show some results, which has also been an initiative for us, [Technical Difficulty] initiative has also delivered because [Technical Difficulty] have the contribution revenue from Michigan, which acquisition that we did [Technical Difficulty] on the basis of constant contribution as per the previous year. But our actual EBITDA was 642 on a positive sense. So bulk of the increase in EBITDA has been coming besides our reduction in [ net related ] cost. We also have a significant reduction in other fixed costs, which is travel, communication, rentals and all that [Technical Difficulty]. We had an increase in people cost, that is primarily because of the increase in cost in Europe and the cost brought in through Michigan acquisition. [Technical Difficulty] been a reduction in people cost or at least flat lining of people cost compared to last year. So other fixed cost, it has been lower than previous year, like I said, and this is really the contributing factors to a pretty good set of EBITDA numbers. Debt has significantly come down from INR 2,600 million or INR 260 crores. It's down to INR 150 crores. Working capital reduction of INR 625 million, INR 62 crores or INR 63 crores. So that's been a very strong performance. So it's very good. So that's really the summary of our financial numbers. From a business point of view, if I start again from Australia, Australia did very well, significantly better than the previous [Technical Difficulty] Southeast Asia was kind of muted. We had some challenge -- COVID challenges both in Indonesia and Thailand, but they have done well. But compared to the other regions, it's a little significant. India had a -- first quarter was -- April was a washout, May was partial washout, and we started seeing a recovery. But it has been a -- it is a surprisingly good quarter for us in India, across all sectors, across all products or people. So this has been a bit of a surprise for us. The economic activity in India is happening, maybe not the large projects, but the compressors that we sell are -- a bulk of it goes towards -- they're not being capital equipment. They are balancing capital equipment. So from that point of view, we have been seeing a very solid recovery in India, and we expect that to continue. But it's very difficult for us to say with clarity whether there will be continued growth in the trajectory that we have created, primarily because the Diwali season is coming, people are out there, we don't know what will be the infection rates, whether there will be a second wave like it is happening in Europe, and whether the government will resort to certain strong measures. So we have to wait and see. But as of now, the business outlook in India is good. Gulf has been a bit of -- has not delivered to what it promised. It's pretty better than previous year, but nowhere near what we're supposed to be doing. Europe, like I said, the initiatives are beginning to pay off. All the businesses are growing there, which is a positive thing. U.S., also, all the businesses have grown, have done better than the previous year. So we expect that Europe and U.S., if external factors are not disrupted, we will continue to see some positive -- continuation of this positive outcome. Now the subsidy that we received from Australia and the U.S. was significantly high in the first quarter, substantially lower in the second quarter. We won't see any of the subsidy in the third and fourth quarter, unless the U.S. government brings in another set of initiatives -- interventions in the economy. We don't know. Nothing clear about that. There is a lot of conversation about significant intervention, but we'll have to wait and see with the change in the presidency and all that. How that works out, we'll have to wait and see. So this is really the business side. As far as the outlook is concerned, like I said, in -- on sales, we see some marginal growth in the third quarter and the fourth quarter compared to the second quarter. Material cost, very surprisingly, has been -- has started becoming a challenge. I don't know whether it is labor issues, pricing. Steel prices, for instance, have gone up by 10% to 15%. And I think the automotive demand is probably causing it. And a lot of the steel companies -- factories were shut down in the early part of the year. Hopefully, they will open up and supply situation will improve and prices will stabilize. Almost all of our vendors are asking for price [ increases ]. So there is going to be a pricing pressure. We are working towards ensuring that we maintain our contribution over material cost, but it's going to be a challenge. As far as people costs are concerned, we expect it to be at the same levels for the balance of the year. We don't see any need for increase. In fact, there could be some reduction, but we don't want to put anything [indiscernible] yet. Other fixed costs, as it really depends on the business, if business starts climbing up, we expect some of these costs to come back up, for instance, travel. But there are some fundamental changes that we have made, like, for instance, we have decided to shut down all our branch offices and bring working from home as the new normal. So there will be savings in terms of our rental. So those kinds of permanent changes that we have made, irrespective of the growth in the business, we will continue to have the benefit of that. So it doesn't -- other fixed costs will go up. We have -- if you look at the levels in Q2, it has been pretty much at the same level as Q1, which has been a very good achievement by the team in spite of growth in revenue. But there could be some creeping increases in Q3, Q4, but that will be more than compensated by the additional growth investment. So this is really the summary of our business and the outlook that we have. So I will stop here, and then I will wait for your questions. Thank you very much.

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

Sir, my first question is with respect to the compressor segment, which has seen a healthy 12% growth. How much do you think this magnitude of growth can be sustained going forward also? And from which sectors have you seen growth in the compressor segment?

Well, like I said, Ravi, I'm not able to say for sure whether the growth trajectory can be maintained because there are still so many uncertainties that are there. If those uncertainties are not there, we can expect the trajectory to be maintained. But please understand that 12% growth you are talking about from previous year, so that's possible to do. But you can't expect the growth trajectory from quarter-to-quarter because that we started from a very low Q1, yes? As far as sectors are concerned, like I said, it is -- we have been quite surprised that the growth is across all sectors. There's nothing -- sure, certain sectors like pharma, certain sectors like food have contributed disproportionately higher. But it doesn't mean the rest of the sectors have not done well. They've all done well. They've all contributed to our revenue.

Got it. Got it. And automotive equipment...

I wouldn't say -- sorry?

And automotive segment -- automotive equipments have seen a decline, 24%, 25% decline still year-on-year. So can we see a recovery in that in the second half?

We are already seeing some recovery because this is linked to -- that is automotive equipment business grows with a lag in the growth in the automotive segment, right? The automotive segment had a very bad first quarter. They started picking up in the second quarter. We are beginning to see some results of that coming into our business. So we expect it to grow in the third and fourth quarter if the automotive, both 2-wheeler and 4-wheeler, sustain themselves.

Got it, sir. And final question is with respect to the other costs. You had mentioned that some of them are structural, the cost savings. As a percentage of revenue, as the number of bps raise, can you quantify as to what can be retained by Elgi because of the cost saving initiatives that we have now?

I don't have the numbers in front of me, Ravi. I can't really give you a specific number.

Okay. But roughly 50 bps still can be there? 50 bps saving or something of that sort?

Sorry?

50 bps saving can be there, sir?

The biggest cost in [ our business ] is travel, right? Travel and communications are our biggest cost. I mean those are tied to our business, right? If business grows, those numbers have to grow because if you don't, you're going to throttle that, then you're going to compromise on business. We are very careful and judicious in terms of permitting like, for instance, we don't allow for any travel to head office. So we are saying there is no need for people to come to head office, right? So earlier those things, meetings are taking place. Those are all things, fundamentally, we have changed. So it's very difficult to quantify each element by virtue of our new policies and practices.

[Operator Instructions] The next question is from the line of Bhavin Vithlani from SBI Mutual Fund.

Congratulations, Jai and team, for a good performance despite challenging environment. I have a few questions. First is, we have seen improvement in the gross margins. And in your opening remarks, you did caution about increasing steel prices. So would you believe that the increase in the margins you have seen on the gross margin side is where we would have consumed lower cost inventory, would have got acquired during the COVID period? And hence, a normalized level is what we would have seen maybe last year, it comes back to that level?

I don't think it is entirely because of low cost inventory. There was no reduction in cost during the COVID period. So it was continuation of the cost. It was a better -- the contribution margins went up at a gross margin level because of better price realization. There's a geography mix. There is a product mix within the geographies. So it is really not -- and certain strategic pricing decision. Now this has nothing to do with our -- with a lower material cost during the first quarter. So now that we have realized better margins, now the material cost is going up. Now we need to adjust to the extent that it's possible. We can't allow the top line to get compromised by virtue of significant cost recovery. So we have to be a little judicious, which is what we are working on. So whether we'll be able to sustain -- if you look at it today, we are close to about 1.4% material cost level. We are higher compared to Q2 of last year. Now we have -- our goal is to sustain this. Now will we be able to sustain it? That's what we are working on. So not because of lower cost, it is because of better realization that we have gained that, that costs are going up. We need to see, is it possible for us to bump up our pricing or shift in mix to be able to recover.

Sure. Second question is what you had highlighted during the call when COVID lockdown has just hit back, looking for better sweating of the assets where you were also open to using our foundry for third-party projects. Any progress on that front? And how would we see any benefit coming on that side?

We haven't -- we've started the progress. We've started engaging with customers. We've got 2, 3 customers with whom we have started pricing dialogues. So -- but have we got orders into our thing? Not yet. So we don't expect any contribution from the foundry this financial year, but we expect that to happen next financial year.

Sure, sir. And my last question is, if you could give us some highlights in terms of the newer product that we had highlighted about, the oil-free compressors. How are we progressing on that? And if you could break the answer between domestic and international?

Well, I don't want to give specific numbers because it's very competitive or sensitive. I can only say our overall oil-free portfolio has done exceedingly well across the world, both in India as well as in international markets. In international market, the starting point was -- starting base was very, very low, almost 0. So from that point of view, it looks very -- it looks phenomenal. But numbers are still -- when you look at it in absolute numbers, it's not significant yet. Whereas in India, we have really pushed ourselves into the market. Our starting numbers are not as low as international. In spite of that, our growth has been very good, very positive. And within that oil-free segment, our new AB Series has done exceedingly well. So it's a very positive move for us. And part of -- when I said product mix, part of it is also because of this.

Understood. Sir, 1 more question, if I may. So on a macro basis, we are seeing a lot of the companies in the electronics and the semiconductor industries looking to set shop in India given the PLI scheme of the government. So as Elgi, what kind of benefit that we would see as some of these companies come and set shop in India?

Well, our oil-free compressors would be a critical requirement for the semiconductor. We're already doing -- supplying to companies outside the country who are involved in semiconductor business. So definitely, that will be an area, but we'll have to wait and see. There was a lot of talk about becoming -- building semiconductor business in India many, many years ago, nothing came on. So we'll have to wait and see whether this is something that will be sustained.

The next question is from the line of Harshit Patel from Equirus Securities.

Sir, could you give us a sense of share of aftermarket revenues for the second quarter as well as the first half of FY '21 versus what it was last year?

Sorry to interrupt, sir. Sir, your voice is echoing a bit.

Hello?

Yes, I'm not able to hear you very clearly.

If you can come closer to the instrument?

Hello? Is this more audible?

Yes, yes.

Sir, my question was on the aftermarket, sir. Could you give us a sense of share of aftermarket revenues in the second quarter as well as for the first half of FY '21? And how it would have improved versus last year?

I don't have the numbers in front of me, but I can give you some anecdotal directional answers. Our -- when I said the reason why we have improved our gross margins, I said there is a product mix shift. One of the product mix shift is the aftermarket shift. We have done better in aftermarket compared to the previous year. In addition, we've got better pricing in our aftermarket this -- compared to the previous year. So both of these are very positive. And we continue to see that very strong traction, not only in India but in the rest of the world.

Sure, sir. And secondly, sir, going by the press releases that you have made recently, I think we have started expanding our distribution network at a rapid pace in USA. So sir, could you give us some more flavor on this saying as to what kind of distribution model we are building there? I reckon most of them are joint ventures.

No, no, no. These are not joint ventures at all. There are -- we have today 4 joint ventures, and these are areas that we strategically pick. Our first preference is to bring on board independent distributors. And if we are unable to -- and that too in strategic geographies of a given country. So if you look at the U.S., we have identified the top 20 geographical areas of the U.S., which contribute close to 60%, 70% of the revenue. And in these geographies, we have to have distribution. And wherever we are unable to get independent distributors, for us, the last -- one of the options is to create a joint venture, which is we have done in 4 locations. So the growth in distribution has been positive. In the U.S., in terms of increase, is not as high because we have been in the U.S. for the last 5, 6 years. There is a certain maturity in the distribution model network and incremental small increases are there. Whereas in Europe, which is -- we incubated Europe 1.5 years ago, and we are beginning to see very high traction in terms of number of distributors that have come from there.

Understood, sir. Sir, if I can squeeze in 1 more question. You had earlier indicated that you would start production of motors for both U.S. and Europe market as well. So the validation trials were going on when we had interacted last time. So sir, have we made any progress on that front?

The last time we spoke, we said validation was going on in India, and that has been completed. We have started supplying motors to the Indian market on a regular basis. We are unable to increase the volume, primarily because 1 critical machine that we have ordered is stuck in Germany because of this COVID condition. Once that machine comes in, and we don't know when it is going to come and get installed because of all the uncertainties in inspection and transport, there will be a significant increase of supplies from that launch for our Indian requirement. The motors have been made for U.S. validation and they are going out -- will be going out to the U.S. market this month. And in the next financial year, we'll pretty much cover all the major geographies as far as the motors are concerned.

The next question is from the line of Jeetu Panjabi from EM Capital Advisors.

Jai, I wanted to ask you a high level -- yes, I trust everything is okay. I wanted to ask a high-level question. As you see -- I mean I heard you see a lot of permanent changes where you said the branch guys are no longer having to come to headquarters and a few of the things that you talked about. What are the opportunities that you kind of see coming out of the COVID? And is there anything disruptive that could change the trajectory of the business over the next year or 2?

I -- there is nothing disruptive in terms of the application of compressed air. I don't see any change happening there. It is just a matter of how you conduct your business. For us, what we are seeing as a result is what we have been doing. The work that we have done over the last maybe 3, 4 years, which has significant [Audio Gap] that we incurred in Europe -- in America 2, 3 years ago is now beginning to show results. The cost that we incurred in Europe last year is beginning to show results. The cost that we incurred -- investment that we made in Australia is beginning to show results. So it just so happens during the COVID time. Now if the COVID had not happened, maybe the growth would have been even more for us, right? So the fact that we had or we have created an international profile, geographically diversified profile, of the business is what has really helped us in the last couple of quarters.

Fair point. And my second -- yes -- go ahead, go ahead, sorry.

The fundamental deliberate decision of the company and it has been systematically executing on it. I know that in the process, there were delays in getting the results. But -- and we did -- there was some angst in the investment community whether we were going in the right direction, but this is -- the last 2 quarters are a redemption of that -- the direction that we have taken.

Fair point. Fair point. Second question is I'm kind of saying, if I were to take a base case that you have a huge U.S. and European industrial boom, right? And actually, that's my base case. But -- so I'm saying, if I'm assuming that plays out and it's more visible in the -- from March or June onwards -- March or June '21 onwards for the next year or 2, it's kind of super cycle feel that you kind of see what's happening in the developed world and that transmits to Asia and India, especially. As you see -- if you see that story play out, you would -- in my view, would you obviously participate in it and see excellent numbers and excellent growth rates play out? Would that be a fair way to think about it?

Well, we are now present in a significant in -- I wouldn't say significant, in a substantial manner. Our presence in these critical geographies is strong. If the economics of the -- economic conditions of the geographies improve, definitely, there will be a gain for us. But we've got to understand we are at the bottom of the ocean, right? Our market share in most of the countries is very small. So it really doesn't matter whether there's economic growth. It's like a fish at the bottom of the sea doesn't worry about the storm at the surface, right? It will continue to remain and grow. And that's really where our growth is coming from, gaining share in the market.

[Operator Instructions] The next question is from the line of Manish Goyal from Enam Holdings.

Very hearty congratulations, sir, on excellent numbers, sir. Sir, would it be possible to share -- you did mention that Q2 had 57% revenue from international. How would that be looked at -- if you look at half yearly basis, how the numbers would be looking, sir?

In half year, our growth has been -- international has gone from 46% to 57%, so almost the same.

Okay. Okay. Okay. So just if I probably dissect the numbers a bit. Still, if I look at India per se, the Y-o-Y revenue decline looks to be -- in Q2 looks to be just 15%, 16%, which still is quite decent. So if you can give us a perspective as to within India, like how is industry segment or infra-related demand? Railways, water well, how is it looking now? How has it been? And how do you see it going forward? A bit flavor on this, sir.

Well, like I said, Manish, we -- industry -- across sectors, on industrial, we have grown. All of them have contributed. We expected many of these segments to be absolutely 0 contributing -- 0 contribution to our revenue. To our surprise, even sectors like foundry or which we thought -- textiles, which we thought that we have -- we would not see any action or any activity, we're beginning to see activity. Of course, like I said, food and pharma have been much more active than the other verticals, but cements has grown, textiles has grown. So there's been activity across the sector. On the infrastructure side, the large projects are continuing to be still very -- I mean there's no activity. Large power plants or steel, there's nothing there. But in the construction side, primarily on roads and infrastructure construction, we see a lot of growth in equipment requirements for that sector, right? So basically, road construction, building construction, that kind of stuff. Railways is a function of the budgetary allocation. It continues to remain at the same level. There is no significant growth there. Water wells is muted, and -- but we have got some significant gains in that segment, primarily on some of our OE customers who are exporting their machines to various parts of the world. So there we have got some significant gains. So this is pretty much the thing. And aftermarket, like I said, is continuing to grow.

Sure. Okay. Wonderful, sir. And on the exports from the India are concerned that we are definitely seeing very good uptick from our subsidiaries overseas. But how is like our direct exports doing, sir? Or is it that, henceforth, our subsidiaries will be responsible for the international market and direct exports from India may continue to see a decline?

I don't see that at all. I mean our direct exports from India are 2 different -- like Southeast Asia, it's primarily direct export. The -- to Africa, it is direct export. I don't see -- these are markets that we continue to be there. I don't think that, that will change. So I don't see a big shift from direct export to sale through subsidiary.

Okay. Okay. So when we refer to our international sales, it includes direct exports from India as well?

Yes, yes.