Vardhman Special Steels Limited (VSSL) Earnings Call Transcript & Summary

Good evening, everyone. On behalf of IIFL Securities, I welcome you all to Vardhman Special Steels Limited 2Q FY '21 and 1H FY '21 Results Conference Call. From the management side, we have Mr. Sachit Jain, Vice Chairman and Managing Director; and Mrs. Sonam Taneja, Company Secretary and Chief Compliance Officer. Without much ado, I would like to hand it over to you, Sachit, for your opening remarks.

Thank you, Urvil. Good evening, ladies and gentlemen, and thank you for joining us on our earnings call for second quarter and first half ended 30th September. On this call with me are Sonam Taneja, Company Secretary; Mukesh Srivastav, our COO. And unfortunately, last night, our CFO Sanjeev Singla's mother passed away so suddenly, and so he is not there with us, but we have Sunil and Gagan from our finance team to support me. So please, pardon me, if we are not up to date on specific questions or numbers, but strategy, of course, we are all available. So basically, in the first half, we had utilized this time to plan for the future of the company along with Aichi Steel Corporation. And we have given a detailed plan for the same in our presentation as well. We've worked on the plans to generate higher EBITDA per tonne by way of reducing operating cost and of course, higher production. And we are happy to share that, finally, EBITDA per tonne is near the upper range of our earlier guidance of INR 4,500 to INR 6,000 a tonne. Of course, though, in this quarter, some of the items in other income are not sustainable, they're onetime. Roughly INR 2 crores is other income which has come in from the PSPCL, the Punjab State Power Corporation, part of our incentive pending from earlier, which will not be coming in second half. But on operating basis, second half is likely to be better than the first -- than the second quarter. What we also feel is that the impact of COVID from our side in terms of demand for steel, because auto demand seems to be doing okay, seems to be normalizing. Partly was, one, we believe, pent-up demand for autos; and two, because of demand for personal mobility coming in because of COVID leads to a higher demand for cars, entry-level cars and motorcycles. And in the first half, we saw that commercial vehicles demand was lower, but that seems to be picking up now. So we -- tractors have been very strong because of the good crops, both rabi and kharif crops, and the expected -- rabi crop again is expected to be good. So overall demand for tractors and motorcycles also from the rural area seems to be good. Capacity utilizations are back to pre-COVID level. In fact, we are much better than last year's capacity utilization levels. And we've also done a lot of training in this period for our employees. We have got product across our field teams going, identified lots of projects for improvement, both in terms of cost cutting as well as safety improvement and cleanliness improvement and so on. So the benefits of our partners, Aichi, as shared earlier, will come in over time. But the biggest benefit that we are seeing already are in terms of safety consciousness in the company has gone up tremendously after their coming in with the reporting of even near misses, which was never and small first aid -- small accidents require first aid and so on. So all that it is a tremendous consciousness improved. Problem-solving from the root cause are the second big area, which has improved under Aichi's guidance. The third area, which is improving under Aichi's guidance is quality of Vardhman products has always been good, but quality is variability, lot-to-lot variability and within lot variability, those are other areas, which are improving with Aichi's guidance. We are also finding that stability of production is improving at a higher level. Again, these are all consciousness that is brought in because of regular follow-up with Aichi team. In terms of financial highlights for the quarter, volume for the quarter in terms of sales was almost 44,000 tonnes. The year-on-year growth was 32.48%, mainly, as I said, record a very sharp recovery and pickup in demand. Revenue has also been up because of this volume increase, but prices have been lower, and therefore, revenue growth is only 16.3%. EBITDA, including other income, is INR 26.67 crores against INR 7.97 crores, and PBT is INR 15 crores with a PAT of INR 8.94 crores. So that's the kind of performance we had. This seems to be our best quarter ever in terms of sales as well as in terms of profits. And despite the huge loss -- good performance in the second quarter, we're still in loss for the first half because of the large loss in first quarter. But from what our original estimates were in terms of our performance, the situation seems to be much better from that. In terms of return on capital employed, if I look at just second quarter performance and if we remove the fixed deposit of INR 50 crores, which is really the amount put in by Aichi and we removed the income on that also, so removed that from capital employed, the return on capital employed, EBITDA on capital employed for this quarter, if we analyze it, has reached a figure of 16%, which was our first target. So we hope to continue to work at this figure and eventually even improve this figure. I would also like to believe that we are reaching a stage where we would like to revise our guidance for future. So from a range of INR 4,500 to INR 6,000 a tonne, I would like to believe that now INR 5,000 a tonne should be our minimum. Range, of course, for some time, we'd like to increase the range, so I would say, EBITDA per tonne range as what I call as normal profitability should be between INR 5,000 to INR 7,000 a tonne. Anything less than that would be abnormal and anything more than INR 7,000 would also be abnormal. We expect these kind of numbers to remain for 2 to 3 years. And beyond that, once our capacity increases and the full benefits of Aichi come in, including business for export to Southeast Asia towards Toyota Group companies and other Japanese OEMs through the -- with the help of Aichi, we expect this range could improve further from this level also. In terms of return on capital employed, the 16% EBITDA return on capital employed is something we will continue to strive to achieve. But again, 3 years later, we expect to improve this figure from the current levels. Overall, if I look at our employees, the morale is excellent. In these good times now, as I would call it, the way we looked after our employees in the tough times, in the COVID times, in the lockdown period, that seems to have gone deep into our employees because we did not cut any salaries, we did not have any layoffs, we paid full salaries to all officers, managers, workers, we even paid full wages to our contractor workers. Not only that, we have now announced increments for the year for our officers and managers, and we are working on the increments for our -- from January and as well as we are working on the increments for our workers and clerical staff, which is due from 1st January, which will also be announced, hopefully, within November, but otherwise mid-December, and all that will be announced also. So we are on track in terms of our performance. Working with Aichi is going well. Our OEMs seem to be doing well. At least in terms of car manufacturing, it is -- the trends seem to be that this trend is going to -- seems to continue till March because earlier, our expectations would -- were that around Diwali time, the demand would drop. So we were expecting lower demand in October and significantly lower demand in November. October has also been strong, and November continues to be strong, of course, a little weaker than August and September, but October and November continue to be stronger than what we had anticipated. So at this point, I would like to close my opening remarks. And we are open to questions.

[Operator Instructions] The first question is from the line of [ Anil Kumar Sharma ], an individual investor.

I'm Anil Kumar Sharma from Chandigarh. First of all, heartiest congratulations for the excellent results you have given? Sir, am I audible?

Yes, yes. Thank you so much for your good wishes.

Sir, you have given the expansion plan in detail, but the amount of CapEx, is it possible -- if possible? Number one. Number two, share of nonautomotive, we are -- you have written that we are -- engineering varying otherwise. But the share of nonautomotive parts. And number three, cost -- power cost is on very higher side. Is it going to be the same? I have 3 questions.

So first of all, the power cost is in control. So I don't know how you are seeing it at a higher level. So this will remain at this level only. Automotive business is almost -- it's almost 100%. So we have very little -- I mean it's maybe 0.5% or 1% is nonautomotive business. So that's a very tiny percentage. So when we're saying auto, of course, this includes the biggest segment is cars. The second biggest segment is 2-wheelers. Then after that, we have -- going to heavy commercial vehicles -- or I mean commercial vehicles as well as come to the tractor segment. So we're covering all -- and offroad segments like JCB, et cetera, JCB, Caterpillar also. CapEx plan, we had planned to announce at the end of our second quarter Board meeting, but it is still being finalized and discussed with our partners, Aichi. And it will get finalized in the next month or 2. So we will definitely announce -- be able to announce it. Yes, we are sorry we are a little delayed in that area, but we will announce the CapEx plan. The next 5-year CapEx plan, we should be able to announce it by the Jan end or February beginning when we present our third quarter results.

Right, sir. One more question. Exports, that we are at 3%, and you have written that you will be reaching 20% to 25%. Is it increasing on a yearly basis or after 2 years, we will start exporting to some extent?

Yes. So as you would understand that most of our exports, most of the increase in exports will really be to the Japanese OEMs and with the help of our partner, Aichi. So those kind of exports takes time. Whenever you're exporting auto -- steel for automobile, it's a very critical parts where the steel is going to be used for. So it takes time to validate the steel for Aichi to get full confidence on the quality levels and so on. So there are many steps to be taken between now and then. So you will start seeing maybe small impact from third quarter to fourth quarter next year. But real impact of that will start only from 2022, and then it will be increasing every year.

[Operator Instructions] Next question is from the line of Urvil Bhatt from IIFL Capital.

Sachit, So just want to get some more update on the volumes front. So we have done 44 kt in 2Q. That was one of the best numbers that we have done in the last many years. So what is the visibility now for FY '21 and '22? I mean how are you seeing November and ordering in December? So I mean what kind of levels are we targeting in second half? Just want to get some color on that.

So again, we still have uncertainty for the fourth quarter because demand, October is fine. October is already behind us. So November also is going okay. December onward, we should see some slowdown because this is normal. So there's nothing abnormal about it. So the way I would see it that last year, we did 135,000 tonnes in sales, and we could be somewhere near that or -- but clearly, I see us north of 125,000 tonnes.

Okay. Okay. And anything on the mix part? I mean has this -- how has the mix changed during COVID time and now, I mean, in 2Q? I mean are we getting some benefit of improved mix? Or how is the thing at present and outlook for that?

So in the second quarter, we did because tractors were booming in the North and the other sectors have not yet picked up. So in the second quarter, clearly, our sales to the tractor segment had increased. So once the other sectors have picked up, which are our regular sectors, tractors is not that important for us. So third quarter onwards, we will see it coming back to our normal trends of 4-wheelers being the maximum and then 2-wheelers -- and tractors would drop in percentage from the third quarter.

Understood. Understood. And any update on the price negotiations that you have done with the auto clients? Or how is the...

Those are going on, still not concluded, but I would say within the next few days -- we are at an advanced level of conclusion. So some OEMs have already concluded. But the main ones for us are Maruti and Hero because they are our biggest customer, plus for many other -- some of the customers that we are dealing with follow these. So the impact of Maruti and Hero price negotiations is the highest for our company. So those are at the last stages of finalization. So -- but I would say the price negotiations are going well. And the cost increase in raw materials, which happened towards the end of second quarter, we would be able to cover that easily, so -- which is why I was confident in saying that operationally, the third quarter is likely to be a little better than the second quarter.

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

Great numbers. Good job. Good work. So a couple of questions. I heard you say to the previous question that you think after December, things slow down a bit. Can you contextualize that? Is that based on what the OEs are telling you? Or is that based on your own estimates? And is there a risk the whole system is wrong and things just melt up instead of melting down?

Okay. First of all, Jeetu, thanks for your words of encouragement. When they come from somebody like you, it means a lot for our team. So look, this is normal. The sales slowing down after -- just before Diwali is normal. So as you would know that 2-wheeler and 4-wheeler sales, the maximum amount of sales happens just before Diwali. So which means, from our point of view, we were expecting September to be the peak and October the slowdown should have started. This is normal. So whereas this time, what we found that the sales in October continue to be very strong, and November has -- again continues to be very strong. So as of now -- so we are just saying that we -- perhaps a slowdown which we were expecting from October as normal may happen from December. But as you said, we might -- as we've been surprised for October as well as we're surprised for November, may well be that we'll get surprised for December, too. But as of now, we have no information saying that the sales should slow down. And as I said in my opening remarks, the car manufacturing continues to remain strong. So -- but since we also have 2-wheelers in our segment, which at the retail level, there seems to be maybe a slight slowdown in sales, which again is normal. I mean this is -- what I'm talking about is normal circumstances. But if this desire for personal mobility continues to be strong and the other counterarguments say is that once colleges open, then this time, the number of youngsters who will get personal mobility, 2-wheelers. And once offices open completely, still a lot of offices in the big cities are work from home and so on. So once those offices open, maybe there'll be a second spurt for demand for 2-wheelers. So our ability to predict all those things is very low. So we are just saying in terms of guidance that we are ready for a slight slowdown, which is expected -- which is a normal behavior.

Okay. Understood. Understood. And tell me, the second question is your spread or margin -- gross margin that you're making on the -- see, that next, whatever, 3, 6 months looks okay if you had the price increases that are within the range of expectations. Is that a fair -- I mean...

Yes, yes. Yes. So we are reasonably confident of third and fourth quarter both being on track and better than our expectations. And as I said, in all probability is better than the second quarter.

Okay. Superb. Good luck. Keep up the good work.

Thanks, Jeetu. But again, what we are saying is this is as of up to March. April onwards will again depend on the price negotiations changing because, as I said, there is possibility of the price increase that we are expecting to be a little better than our cost increase. So whether the numbers that we get because slight improvement from second quarter, will those numbers be sustained next year in terms of pricing, I don't know. But I will also say that our teams have worked very well on the cost initiative. So those initiatives, which are on the cost side, those initiatives remain with us, which is where we are quite confident of saying that the range we are revising upwards.

Next question is from the line of [ Manish Segal ], an individual investor.

Congratulations on a good set of numbers and good performance from the team, and congratulations to all the team. I just want to check whether you mentioned that the range will go from INR 5,000 to INR 7,000, and there's a scenario where our price hike is higher than the raw material increase. So are these the next 2 quarters where we go beyond INR 7,000 as well in an abnormal situation?

Very difficult to say, but we'll clearly be on the upper -- we seem to be on the upper end of this range. But how much higher we go, we can't say at this point in time till the prices are finalized. And I would not let you speculate unnecessarily and then be proven wrong. But as of now, the reading is it will be towards the higher end of our new range.

Okay. Great. One more question. INR 2 crores is the number that you said was onetime because of the incentives. Apart from that in this quarter, what is the incentive number, which may not have been there in the previous year's numbers?

So see, there are 2 other figures that occur in the other income, which have -- which were not there in earlier times. So one is there is this fixed deposit of INR 50 crores, which is the proceeds from the rights issue of Aichi Steel. So that -- the interest on that fixed deposit comes in other income as well as we have this time, in COVID times, the Punjab State Electricity Board was running short of cash, and they put in an appeal to industry that you pay your power bills in advance, and you get a reasonably high, I think, 12% interest. So we deposited our estimated power bill for the full year well in advance. So we are getting interest arbitrage because the interest rate on this advanced electricity consumption deposited is around 12% whereas the cost of our borrowing has been coming down constantly as the rates in the market has gone down. Our latest CP raising was at 4.75%. So we are getting a healthy spread, which is also coming in other income, which was not part of earlier years' income. But this incentive part has occurred in the past also. So -- but these 2 -- the interest income, which is on Aichi's fixed deposit as well as the Punjab State Power Corporation Limited's deposit, these are items that haven't occurred earlier. And since now, every month, the remaining months are lower. So the income on this account will keep dropping. So third quarter will be lower than second quarter and fourth quarter will be lower than third quarter because the deposit is till 31st of March.

Okay. One final question, Sachit. Sorry, my apologies on taking more time. Do you think that the growth numbers that you're putting out in terms of volumes going to 250,000 and 300,000 over the next 8 to 10 years is conservative given where we are from a country's perspective, a 50% growth in 10 years is slightly conservative in volume terms?

No, no, no. This is the sales that we will be expecting from this plant. So this is a maximum that we can get out of this plant. 300,000 tonnes would be billet production, which means from that, you are to take out the wastages. So the sales, maximum sales that we expect from this plant would be of the order of 260,000 to 270,000 tonnes.

Okay. Are you planning another plant?

So clearly, from 2/3 -- so this part is up to 2025. So around 2024, 2025, depending on how the Indian business is progressing, depending on how Aichi and Vardhman teams together see the confidence in the way our people have imbibed the culture and quality levels of Aichi and our ability to satisfy Japanese OEMs in Southeast Asia, especially Toyota for critical parts and so on, so once that happens, then very clearly on the annual is plans to put up -- to look at expansion. But we have already said that our long-term vision by 2030 is to -- if all goes well, to reach between 800,000 tonnes to 1 million tonnes of steel capacity. So that remains on track. But the -- that's the vision. We haven't talked about it in detail just now because the decision on that will be taken only in 2024.

And anything on the annual in the near future in terms of, say, an acquisition or something?

See, those are things that there's no firm plan, but the way things are going if all goes well and Indian market continues to be strong and the way our customers are responding to us, we feel that our growth internally could become a little higher. And then -- and if Aichi develops confidence in us earlier than the schedule so far, say, volume starts coming a little bit earlier, then we might run into capacity constraints. But before that, the important thing is to get the environment approval, which allows us to expand, as you would know. As of now, our capacity is capped at 200,000 tonnes of melting. We have got the terms of reference which seems to be the first set of approval from the Ministry of Environment, which means there is -- we are reasonably confident that by March or so, we should get the approval from the Ministry of Environment for expansion. Once that happens, then that clears the way for expansion in this plant. However, if that does not happen, then we will be in trouble in terms of not having enough capacity. And at that stage then, an alternate strategy of an acquisition or some such thing could become imperative. Let me say out here that we are -- our team is reasonably confident that we should get the approval by March. We would have got it earlier, this COVID has delayed things by, I would say, by 6 months. So what should have happened by now is really -- may happen by March.

[Operator Instructions] The next question is from the line of [ Shivani Mehta ], an individual investor.

Congratulations to the entire team. I have 2 questions. One, what kind of EBITDA per tonne do we expect in the tractor segment?

So we don't release EBITDA per tonne segment-wise. But suffice it to say, at the tractor segment, the EBITDA per tonne is extremely low.

Okay. And our INR 6,000 per tonne EBITDA in this quarter has been driven by which segment majorly?

I'm sorry?

The EBITDA per tonne in this quarter has been driven by which segment majorly?

We don't declare all that. But as I said in my -- in response to earlier question that the tractor business was higher than normal in the second quarter. And it is for this reason that we are saying that as that tractor segment has already gone down in third quarter, so the average EBITDA per tonne will automatically improve in the third quarter, which is why I was confident that we will be -- despite the -- whatever happens in the price negotiations that we should reach the upper end of the range of INR 5,000 to INR 7,000 for the second half.

Okay. And sir, the EBITDA that has been mentioned, does it take into account price increase? And what are the factors?

It does take into account some aspect of price increase, but till the final amount happen, we are not able to take -- give any false indication -- a false buildup of expectations. We have suffered, as you would recall, some of us -- some of you who have been long-term investors with us, 2018 was a similar situation where we were expecting price increases of INR 4,300 per tonne, and eventually got INR 2,000 to INR 2,200 a tonne. And suddenly, from what was going to be our best year ever turned out to be a disaster second half. So -- but -- which is why we are taking a reasonable increase in the prices. And we are speaking more on terms of our confidence in cost reduction as well as product mix change in the third quarter compared to second quarter, which is giving us the confidence that we should be at the higher end of this range.

[Operator Instructions] The next question is from the line of Karthikeyan VK from Suyash Advisors.

I'm new to your company, Sachit. Excuse me if I'm asking you a fairly basic question. Can you give us a sense of the capital intensity of the business? The 16% seems like relatively modest for the kind of ambitions you're talking about in order to scale up. So...

Okay. Karthikeyan, are you from [ Giku's ] company?

Yes, please.

Okay. Right. Thanks. So see, this is a manufacturing intensive industry and a lot of working capital is involved into the outstanding. And when our cost of working capital is around 5%, then EBITDA to capital employed of 16%, in my opinion, is a pretty good number because it's very to -- because all our outstanding is all part of this capital employed. And most of the -- since we are primarily buying scrap, so -- which is normally mostly cash-based in terms of, meaning, you don't take credit for -- you don't get credit for scrap, you are paying spot basis. So it is a working capital-intensive business also. So in that sense, I think EBITDA to capital employed of about 16% is a reasonable number. However, it is very easy to discount these figures, it is very easy to give a cash discount and reduce this capital employed, and this will increase our return on capital employed. But when you get -- your cost of money is 5%, it doesn't make sense to aim for a much higher figure than this. So sorry to disappoint you, but 16% EBITDA to capital employed is what we believe this is a decent number. And hopefully, once this expansion happens, in terms of approval from the environment, as we increase our production out here, the fixed asset intensity is going to be not so high for our increase in sales and working capital also in terms of our current assets on raw material side will not increase dramatically. Only outstanding would increase. So see, there are some of our customers who -- the payment cycle is 90 days, 100 days, 120 days and 44, 45 days, so all kinds of customers. On an average, our payment cycle is about 65 days. It's very easy to cut out those customers of 120 days and improve return on capital employed. That is not our objective. Our objective is that the cost of interest for us is 5%. It doesn't make sense to cut out these good customers. And [indiscernible] cash-rich company, which is strong in this region and has long-term relationships over generation with some of these customers, we have the ability to take the risk, so to speak, of credit to some of these customers.

[Operator Instructions] As there are no further questions, I now hand the conference over to the management for closing remarks. Over to you, team.

Yes. Thank you so much, ladies and gentlemen. We feel heartened that after a disappointing first quarter we were able to recover some bit in the second quarter. I'm also feeling reasonably satisfied that we have been talking about the range of INR 4,500 to INR 6,000 EBITDA per tonne, and we were expecting that to have happened from last year itself because basically, we were waiting for the expansion, which we did the upgradation of furnace last year. After that, we were expecting these kind of returns, but the dip in auto business, which happened last year, put paid to all our plants. So we were disappointed in our performance. So finally to reach those levels that we had suggested has taken a little longer than we anticipated, but we are glad it is there. And thank you for showing patience for any of you who have been long-term investors with us. And I can only promise you that we are now on a better road. And with the strength of our partners, Aichi Steel, we expect that we will be more consistent performers than in the past. So we look forward to seeing you in the third quarter call. Thank you so much.