Elgi Equipments Limited (ELGIEQUIP) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to Elgi Equipments' Q1 FY '22 Earnings Conference Call, hosted by Asian Markets Securities Limited. This conference call may contain forward-looking statements about the company, which are based on the beliefs, opinions and expectation of the company as on the date of this call. These statements are not a guarantee of future performance and involve risk and uncertainties that are difficult to predict. Actual result may differ from such expectations, projections, et cetera, whether expressed or implied. Participants are requested to exercise caution while referring to such statements and remarks. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Kamlesh Kotak from Asian Markets Securities. Thank you, and over to you, sir.

Good evening, everyone. On behalf of Asian Markets, we welcome you all to the 1Q FY '22 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 the overview of the quarterly 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 so much for taking the time to be with us this evening. I hope I can make this interesting for you. This is a very funny quarter because the reference quarter of the prior year was -- is an irrelevant quarter because for almost 2 months of that quarter, there was no business. So if we -- if I do a comparative analysis of the two, we will look like we are doing exceedingly well. And that wouldn't present a right picture about the current performance status of the company. So I don't want to -- one option was to look at the second quarter of last year as a basis to compare our performance with the first quarter of this year, considering that there was a lag. But that also is a little unrealistic because in the second quarter of last year, the mix of sales was very different from a steady state because there was more of global sales and less of India sales. And as a consequence, the profitability ratios were quite skewed in the second quarter. So we did multiple thing. So instead of the traditional reconciliation that I do, I will talk about this quarter's performance in relation to the first quarter of '19/'20, which was a steady-state year before COVID happened. So when you'll compare it with the Q1 of '19/'20, we have grown our revenue by almost 6%, 7%. And the -- however, at the contribution level, we were lower by 1%. And at an EBITDA level, we were low by 2%, right? So this is how the numbers stack up. If I have to look at the contribution analysis, why did we lose a percentage from a steady state here. The primary reason has been the increase in the raw material cost, which really started in October of last year, and kept marching up, and quite violently kept marching up till February. We did a series of price corrections during this period in the market, both in India and internationally. It seemed to pause a bit in February. But by the end of March and beginning of April, it had a violent upward movement again. And that caught us by surprise. And again, we went into another price correction. And for us, in capital goods, there is always a lag between a price announcement, a price revision in the market and the realization of the revision in the P&L. So we have -- in this quarter we have gone through that uncomfortable period of the lag. We have done multiple. In fact, we have done 5 price corrections in the market. It's been very challenging and difficult to do that. But we went ahead and did it because it had to be done. In some of it, we have recovered; some of it, we have had to absorb. So that's the real reason why we have lost out on contribution in the first quarter compared to the same quarter in '19/'20. So what do we expect? I think this is a more interesting question. What do we expect that this year will be? So let me talk a little bit about the second quarter. In the second quarter, we expect roughly the same phenomenon to continue because price corrections are being -- are happening. The last one what we did was in June. So that will take a lag. So I don't expect a big change in the margin contribution. I don't see it dropping, but I don't see it significantly going back to recover the raw material price increases. But in the third and fourth quarter, combined, we should come back to normal. And I expect that the full year for '21/'22, I expect that the material cost percentage would be almost the same as '21/'22. So we'll get it back to that level. In fact, if you look at the first quarter's material cost percentage, it's 53.7%. And for the full year, last year, it was 53.4%. So with all these changes that we are doing, I'm very confident that we will get closer to that 53.4% number that we had for the full year of last year. Now over and above these price recoveries that are happening, we have -- we are in the middle of -- final stages of rolling out a very, very comprehensive cost reduction program at the material cost and variable cost level. Our targeted reduction is 2% on our revenue. So that -- the project that is going to happen is going to take us over a 10-month period. So part of that 2%, we will also realize during the current financial year. So that's why I'm very confident that by the end of this financial year, at the worst case, our material cost percentage will be the same as the previous financial year. So having said that, what about the top line? Now if you look at the top line compared to, again, Q1 of '19/'20, we have grown about 6%. Now this 6% is a -- doesn't reflect the actual situation of the company and the market. We could have grown another 7% to 8%. We had the orders. We have the thing, but we just had supply challenges. So -- which we have overcome in -- quite significantly in June and July. So therefore, I'm very confident the second quarter and the quarters to follow, the growth in revenue is going to be a lot more compared to '19/'20. And I expect the -- when we close the year, our growth -- our top line growth, at the worst case, will be at the low to mid-teens at the minimum. So my expectation is even if there is a few percent -- points of fractions of a percentage challenge on material cost, we will more than recover on our leverage. So on the top line, it's going to be a very positive number. Just to give you a little bit more background to that confidence, India has been -- has recovered very well. Unlike the first wave, the second wave had dislocations in regions, first in Delhi, Maharashtra, then it came to the south. And by the time, the South got really intense, Delhi and Maharashtra kind of eased up and business started happening. But everywhere, the underlying desire for business and a positive sentiment remained throughout the second wave. There was -- it was always there -- it was the inability to deliver, which was a constraint, and not the demand itself or the buoyancy in the market. So for us, in Coimbatore, our plant was running without any stop. We had no issues with -- the team did an excellent job of managing infections of our people. Very few, very low incidence of infection internally. And very little serious repercussions of infections in our company was done, handled very well. But our biggest challenge was our local suppliers. Their factories had to be shut for extended periods because their employees got infected, pretty large percentage got infected. So that really challenged our ability to supply. And that's why I'm saying that we could have done a lot higher in top line compared to what we actually did. So that buoyancy and optimism goes into the second quarter and onwards. Now from the market side, like I said, India, there is still a very positive sentiment. Europe is -- the revenue is tracking higher than what we had budgeted as part of our strategic plan to invest. So it's a very positive thing. The U.S. is coming back from a very low economic activity. But even in that low economic activity, we continued to grow in the U.S., which was very positive. With the additional stimulus and the infrastructure spend, we look forward to a very positive response from the market for our products in the U.S. So it's very positive there. The biggest challenge for us is really OSEA, which is Oceania and Southeast Asia. Australia has -- going through serious lockdowns of cities in pockets, Sydney, Melbourne, now Brisbane. And Southeast Asia, our key markets like Indonesia and Thailand and Malaysia are facing some serious infection-related lockdowns. So we'll have to wait and see how these markets -- so the first quarter performance of Oceania -- Australia was good. But towards the end of the first quarter, they went into lockdown. But the rest of the Southeast Asia was quite challenging throughout the first quarter. But I believe that they will come back. So we are very confident that with all this, the top line strength is going to be quite strong for the balance of the quarters. Now in terms of preventing the same inability, I believe that the third wave is not a question of if, it's a question of when. And when it does happen, how do we ensure that the supply inabilities that we inherited or experienced in the second wave, we don't replicate it in the third base. Now we have done aggressive vaccination programs within the company. Now 91% of our people are working, who have to come to work have been vaccinated the first shot, and 40% have been vaccinated on the second shot. And we are taking this vaccination program to our contract employees as well as the employees of our suppliers. So we are putting a lot of diligence into it. And hopefully, in the next few weeks, we will start to see percentages increasing in all these segments of people who are -- who have a strong bearing on our supply capability. The third major cost is employee cost. Now again, last year is not a comparison because there were a lot of subsidies from the U.S. and Australia, specifically, which kind of distorted our employee costs. So if you add those subsidies back as a steady-state cost and remove the money that we spent on our VRS that we launched in March, the increase in our overall cost that we expect for this year, so if we go back and say, what will be the expected cost -- manpower cost end of March of '21/'22, it will be about between 9% to 10% growth over the corrected number, the corrected number for 2020/'21. The corrected number -- the published number is INR 4,117 million, of which there was a subsidy of INR 242 million and a VRS of INR 37 million. So if you net all -- add the subsidy back and deduct the VRS amount, it's coming to INR 4,322 million. And we expect the annualized cost this year, including headcount increases is INR 4,746 million. Now many of these headcount increases are a function of timing and traction in the business that we need to. So this, in the worst case, will be about 9% to 10%. The actual salary increase that we have done is hovering between 6% to 7% for this year, which has been a very reasonable percentage compared to what's happening. But there is -- with the IT industry announcing the kind of percentages and bonuses, this is a bit worrisome in terms of our attrition of talent, but this is what we can afford, and we need to manage around it. So if I take all these factors into account, I think we have a reasonably optimistic year to look ahead to. Sales will be a good growth. Contribution, at worst case, will remain at the same level as the whole of last year. Manpower cost would go up maximum between 9% to 10%. The other fixed costs will be a function of how we do our growth on the top line. If it's not there, it's not going to be there. If it is there, it will moderate itself. So at the end of the day, our EBITDA, under normalized conditions, would be, at a percentage level, a little higher than what it was last year -- percentage-wise last year on a much higher top line. So this is really the summary of our business in Q1 and what we expect for the balance of the year. So I will stop here, and I will rely on your questions to clarify more. So thank you again for this opportunity. Thank you.

[Operator Instructions] We have a first question from the line of Ravi Swaminathan from Spark Capital.

Sir, my first question is with respect to the domestic market. If you can give more clarity, granular details on how the demand is there from infra side, industrial side, SME side? How it is compared to, say, last year or last to last year? It will be really great, sir.

Okay. So in the first quarter, there was one segment which was kind of disproportionately significant. I wouldn't say that was a large proportion of our sales. I don't want to give the specific numbers. This was compressors required for oxygen generators. Now we were approached by DRDO, who had licensed the production of these oxygen generators to L&T as well as Tata Advanced Materials Limited. And we were to give a large number of compressors in the months of April, May and June, and that continues -- that continued into July as well. And we focused on -- we prioritized this supply. As a consequence, we could not supply to certain other segments. But it was very gratifying to see as most of our customers were understanding of the reason. So they did not cancel orders. They stayed with us and took a deferred delivery. Now so if I take the oxygen piece out and talk about the market, the buoyancy and inquiry and orders were very solid across all segments. And in industrial, we saw activity across all industry verticals. There was not -- even automotive, which was challenged, the automotive component suppliers were looking at buying compressors to increase their capacity. So it was -- I can't say that there was one segment that stood out, not at all, right? The first wave, we were thinking it will be food and textiles -- I mean, sorry, food and chemicals and pharmaceuticals, but unlike that, this was across all, so even construction and mining, water well. Water well, the regular business has not come back, but there was -- the OE customer segment was very strong for supply of complete packages to African countries. And we have a very good share in that market this year. We are hoping that this market opens up this year, and I'm very glad to say that the new product that we have launched and we have been testing for the last 1.5 years has gone very solid traction in the market. So when the market opens up, we are ready to regain our position in that market. This time, very, very confident. So the -- all across, it was there. There was a pause in the month of May and June on our aftermarket, right? Because plants are not running, nobody is going to buy spare parts. So that's one more reason why you see there was a challenge on our contribution. And that's come back now strongly, right? So I can't say there is any one industry, it is across the board.

Got it, sir. And would the inquiry levels -- is it safe to say it would have grown by kind of a double-digit number in terms of volumes, et cetera?

Sales would have grown double-digit compared to FY '20 first quarter, yes?

Okay. Okay. And...

Now we have grown only 5% or 6%, but we would have definitely done double-digit growth. It's not for the constraints that we have.

Got it, sir. And with respect to price increase, what could have been the approximate magnitude of price increase that you would have taken? And is there any other price increase which might be there on cards to compensate for the...

The last -- like I said, the last price increase was done in June. Combined price increase, I'm talking on average, is about 15%.

15%. And...

Over 5 installments, 4 to 5 installments.

And is there any resistance from customers, given the fact that 15% price increase is on the steepened side?

Obviously, there is resistance. It's also a function of a lot of competitors delaying that. So customers point to that. But the reality is everybody knows that in every business, right, in every commodity, there has been an increase in price, right? So this is not something that is Elgi's inefficiency, right? It is a reality that is hitting everyone.

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

Jai, good performance amidst the challenges. I have a few questions here. On the consumer products that we would have launched, so, one, on water well, you did outline, but if you could also highlight about the oil-free compressors. How has that been tracking because that was one area that you were expecting to change your growth to profit?

So on our oil-free machine that -- we have 2 category of products: the conventional 2-stage dry screw, and then our water-injected AB Series. Now both of them have grown exceedingly well in the first quarter, right? Not only in relation to the prior years but also in relation to the fourth quarter of last year, which was itself a good year. So -- and it is not just in India, but globally, right? So this has been a very positive thing. Now on our AB series, we have now expanded -- in another few months, we will be introducing those products. We've expanded the range. Now from 11 kilowatt up to about 110 kilowatt, we will have oil-free machines using that technology. So it's a very positive thing that we are sitting on. And the growth has been good. I don't want to give specific numbers, Bhavin, because I don't want -- that's very sensitive from a competitive point of view.

We appreciate that. The second question is in [Technical Difficulty]

Bhavin, you are -- for some reason, you are breaking up. I don't know why, but your voice is coming out crackly.

Is it better now?

Yes, it is.

Okay. All right. The second question is, you did highlight that total price actions of about 15-odd percent over the last year or so. Would it be possible to share maybe some of the key categories? What would be our premium or discount to the market leaders, be that KAESER or an Ingersoll because actually, the feedback always used to be that...

So the price increases that we have done, I think, on average, are higher than what the competitors have done. At least, that's what the information is. But I have a feeling it's not a question of competitors not increasing. It is a question of timing. When you're sitting -- it all depends on which company is sitting on what inventory at what cost, right? So the minute they use up old costs, then the price increases at times. So it is only a matter of time because it's not something that is unique to Elgi. I mean you look at cold-rolled steel or hot-rolled steel, you look at scrap, everything has just gone through -- copper, aluminum, all gone through the roof. So in terms -- to answer your question, in India, are we at a price premium? We're not at a premium. Are we at a deep discount? No, not at all. In Europe and the U.S., are we at a discount? Yes, we are. Is it deep? No.

Yes, sure. Appreciate it. The second part is, if you could give us an update on the motors facility. In the previous call, you mentioned there were certain challenges, lack of material to restart -- I mean, to start the factories?

Yes. So the challenge was not lack of material. It was a machine that we had ordered with a German supplier, and it got stuck in COVID, and then they had some technical issues, which continues to keep hampering us. Even now, as we speak, that machine has not come. But the team has parallelly developed an alternate method of producing the motors. So today, we are producing close to -- 40% to 50% of India requirement is now coming from our motor plant, right? Now we are still hoping that we will get this machine in. Once it comes in, we'll be able to increase that percentage quite significantly. Now it's not a question of raw material, it is just this machine, which just -- the alternative is to do it manually, which is a bit laborious, and it takes time. And therefore, the output is not as high as we would like it to be. Nevertheless, alternate arrangements have been made, by which we are making close to 40% to 50% of the Indian markets' total motor requirement.

Sure. Appreciate it. And just last question from my side. Over the last year or so, we have seen a considerable increase in the logistics costs, especially the sea freight challenges on the availability front, which could be shorter term. But on a more structural front, the policy of most of the Western countries are getting more internalized. And for us, we have a large location in India. So do you believe maybe not in the near term, but in the longer run, maybe having some assembly operations closer to the customer, given the changes we are seeing on the geopolitical fronts?

The decision to assemble closer to the customer or manufacture closer to the customer will be a function of that with a value proposition to the customer, Bhavin. Not -- it will not get dictated by the current short-term shipping challenges, right? Now I say that because it doesn't matter where you are in a globally interconnected trade -- trading world. You are going to -- whether you assemble in Europe or India or America, you'll still have shipping. Now you have shipping of machines. Tomorrow, it will be shipping of parts, right? So you'll still have those issues. So that's not a relevant factor in that decision. But you're right, we need to -- there is a geopolitical dimension. Every country is exhibiting very protective behavior, right? So we need to -- that needs to get factored in. But the more important thing is from a customer's point of view. And the third dimension is we need to -- we are not a company that is producing compressors at European or American labor cost. We are producing compressors at Indian labor cost. And that is a large contributor to why our cost structures are low. Now we are working on a program, which I've talked about multiple times in the past, where we are able to make compressors at the -- by paying salaries that are European or American and still be profitable at the current level. Now that is a project that is continuing to be worked on. Now until such time, and we think that is going to take us maybe 3 to 4 years to get to that point, now we are talking about close to a multiple of 4x the blue collar employee at the current level, not that we are going to pay but that's the cost that we need to be able to absorb and still be profitable. Now it's going to take us about 3 to 4 years. Once we are ready there, then we can look at it. Otherwise, we start assembling now, the cost is going to make you uncompetitive.

[Operator Instructions] The next question is from the line of [ Ritwik ] from One-Up Financial.

Sir, a few questions. Firstly, on a clarification. You mentioned in your opening remarks that we are looking at mid-teen top line growth in FY '22. So is that over FY '21 base or FY '20 base?

Sorry, can you rephrase that question, please? Or repeat that question?

Yes. You mentioned that you are looking to do mid-teen top line growth in FY '22. So is that over FY '21 base or FY '20 base?

FY '21.

FY '21. Okay. Sure. And sir, is it fair to assume that the current employee cost around INR 118 crores on the consolidated level will continue for the rest of the 3 quarters as well?

So this is the point I -- so this is what I explained to you. Last year's employee cost was about INR 412 crores, right? And out of that INR 412 crores, we had a subsidy of INR 24 crores, right? This is -- that is onetime, the job keeper subsidy and the payroll protection program in the U.S. and Australia. That is not there now, right? So our payroll cost -- our employee cost was lower to the extent of that, which is not an increase, that is just a subsidy. So if you add that back and then reduce the money that we have spent, about INR 3.7 crores on VRS, which is not going to repeat, the adjusted FY '21 employee cost is INR 432 crores, right? So against that, our expected employee cost for the year, this current year, is INR 475 crores. So that represents a growth of around 9% to 10%.

Sure. Sure. That clarification is helpful. Sir, my next question is on the split between India and rest of the world. How was it in Q1 FY '22?

Sorry, say it again, please? I missed you there.

Yes. Revenue split between India and rest of the world for the quarter?

In terms of sales?

Yes, in terms of sales?

Yes. Yes. So roughly, the sales today, the current run rate is 50-50.

50-50. Okay. Sure. And sir, in your opening remarks, you mentioned about cost-saving initiatives, about 200 basis points on the top line. So what are these programs? Can you elaborate on that?

So basically, we are focusing on, like I said, variable cost, which is -- if you look at our variable cost structure, 90% is material cost, right? And the other 10% of our total variable cost is other variable cost like electricity and small consumables, right? So the plan is to take cost out by maybe alternate material, reduction of weight, changing design, renegotiation with vendors, new vendors. So it's a combination of using both technical levers to reduce costs and commercial levers to reduce costs, right? So it's a very structured program. And we are creating it -- we are pulling very talented people within our company to head it on a full-time basis. So I'm very confident that we will achieve this.

Okay. Okay. So taking a medium-term view, a couple of quarters back, you had mentioned that gross margins can be in the range of 47% to 48%. So would it be fair to assume that once this raw material cost stabilizes, then -- and the cost-saving initiatives that we are taking, would it be fair to assume that what, say, in 2 years, we can do gross margins in the range of 49% to 50% once we realize these cost-saving initiatives that we are doing?

So you're talking at a level of material cost of 50%?

Yes. Yes.

Right. Material cost hitting 50% is going to be a function of better pricing, one, as well as lower cost. Now if you look at that 2% that we are going -- we have planned to get, which we're very confident, and if you bake that into a 2021 number, it's going to be already 51.4%, right? Now when we change our mix to start selling more of oil-free machines, more of aftermarket because the more you install machines, the more your aftermarket is going to grow. It is that -- hitting that 50% is not an unrealistic target, yes? But in our strategic plan that we had announced to all the analysts and investors, well, we are talking about keeping an EBITDA of 16% in '23/'24 is without taking these into account, yes? So that's a purely leverage-driven growth in EBITDA, yes? Whereas, this is going to be an added factor. So those are -- and I had mentioned that even when I made that announcement that these are things that we have not taken into account.

And we are looking to do this in 10 to 12 months' time, right?

Yes.

Okay. Sure. Sir, and my last question is related to Europe. We are seeing -- we are investing in to increase our geographic footprint there and investing in personnel as well. So when do you think that this will fructify in terms of top line?

So the top line, like I said, we have made a 5-year plan. And we said at the end of the fifth year, we are going to break even, and then start becoming positive. Now we -- as far as the top line is concerned and the extent of loss, we are better on top line and lower on the loss that we had planned. So we -- Europe is growing really on the right track, right, in the right direction and -- that we wanted to go as far as this project is concerned. So the final number for Europe is actually the '24/'25.