Varroc Engineering Limited (VARROC) Earnings Call Transcript & Summary

Good day, and welcome to the Varroc Engineering Conference Call. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Tarang Jain, the Chairman and Managing Director. Thank you, and over to you, sir.

Thank you. Tarang Jain here. Good afternoon to everyone, and I would like to thank you all for joining the call of Varroc Engineering Limited. We're having this call to appraise (sic) [ apprise ] our stakeholders about the divestments of the 4-wheeler lighting business in Europe and America. We will also talk about how the continued business is progressing for the company. Firstly, in respect of this divestment, I would like to highlight some important changes. The continuation of the Russia-Ukraine war leading to higher inflation, the consequent tightening by the central banks and the semiconductor supply shortages continue to impact both the supply and demand. This has resulted in lower demand, higher raw material prices and labor costs during the current year, especially the operations which are based in Europe and America. Economists are also forecasting recessionary trends in developed countries in the near future. On the backdrop of this and to take care of the buyers' concern, we had to amend the enterprise value from EUR 600 million to EUR 520 million. Further, we strongly believe that the patent infringement cases which were filed by Valeo will be nullified by the German Court. The independent third-party opinion, which we obtained also supported this view. However, the verification process requires a further 12 to 18 months of time. Considering the urgency of concluding disease, we had to agree for an out-of-court settlement for a higher value of EUR 51 million. Moreover, the debt and debt-like items have further added up to approximately EUR 56 million compared to our earlier estimate of EUR 25 million to EUR 30 million. Details of the same are given in the presentation. Hence, as communicated in the AGM, the leftover equity value will be significantly lower than what we had estimated earlier. The net cash accretion, excluding escrow will be also lower at EUR 5 million to EUR 9 million as compared to EUR 160 million estimated earlier. As a result of this, the net debt in continued operations will only come down marginally, though there will be a significant reduction in the consolidated debt. These changes will result in write-down of investments and advances. We will also have another EUR 28 million in the escrow account and most of what of that is expected to flow to us in the near future. Conclusion of the deal will result in avoidance of further debt burden on Varroc India, besides enabling us to focus on high-growth and profitable segments of our continued operations. Some of the highlights of the continued business, I would like to share some positive developments in our continued businesses. The operational performance of the continued business is steadily improving. Firstly, the Indian operational revenue for this quarter, that is Q2 FY '23, will be the highest ever in the history of Varroc. Secondly, we continue to see strong new business wins from incumbent as well as new players. Thirdly, the VLS remaining operations is also improving its operating performance. And lastly, the forging business in Italy, which is called IMES, started delivering positive EBITDA margin as we have seen in Q1 FY '23. In a future strategy, prudent capital allocation and free cash flow generation will get a lot of focus. I will now request our group CFO to walk you through the presentation, which has already been uploaded in our website and on the stock exchange. Over to you, Mahendra.

Thank you. Thank you, Tarang. Good afternoon, everybody. Welcome to this call once again. I'm happy to talk to all of you once again in my new role here. As Mr.Tarang explained, the presentation has been uploaded in the website already. I think some of you or all of you might have seen it. I'll take you through the presentation right now. On Slide #2, we try to explain what was the initial assumption or proposal when we actually started the deal a few months ago. And on the right side, in Slide #2, we expand the changes which have happened in the final settlement. So as you can see, and as Mr. Tarang also explained earlier in the call, the EUR 600 million of enterprise value had to be brought down to or amended to EUR 520 million considering the current economic scenario across the globe. As you also might have noticed in various press releases and news items, across the globe, the merger and acquisition activity has come down significantly. In fact, I was reading news reports that between U.S. and Europe, the merger and acquisition activity went down this year by close to 50% to 60% compared to last year. So our focus was mainly to basically save this deal or conclude this deal. So and also the continuing outlook also seems to be somewhat a matter of concern because all of you know that Europe is going through a lot of recessionary fears. So to accommodate these requests and these concerns of the buyer, we have to bring down the value from EUR 600 million to EUR 520 million. And then this out-of-court settlement also had to be finalized by EUR 51 million, though we had a strong case to fight it out. Again, in order to conclude the deal, we had to agree for this high amount of settlement. But the good thing is this will actually put rest to all these disputes, which have been hanging for some time. And then the net cash accretion to Varroc will now come down to EUR 5 million to EUR 9 million. I will explain the walk in the subsequent slides. And another positive thing here is the escrow, which was earlier pegged at EUR 35 million has now been brought down to EUR 28 million. So with this, we concluded the deal yesterday and the settlement also has happened. And the overseas debt and debt-like items of approximately EUR 400 million have been settled. Now this is another positive development for us the way I see it because this much of debt burden or debt-like items burden has been washed away from the consolidated balance sheet, which should give us good kind of relief going forward. I will take you to Slide #3. This explains the walk, what we presented earlier versus what it is now, just so that all of us are clear about the walk. We previously, as you might remember, the enterprise value of EUR 600 million after all these adjustments for debt and debt-like items. It's supposed to result in net cash accretion of about EUR 157 million to EUR 161 million. With this reduction from EUR 600 million to EUR 520 million and the Valeo settlement coming in, the net cash accretion will now come to EUR 5 million to EUR 9 million. Enterprise value reduction, we already talked about. So because of all these economic factors and the cost pressures, the raw material inflation and labor costs also have gone up in European countries. So that created some kind of a bleak outlook for the future for these operations. So to allay the fears of the buyer, we had to go for this kind of a correction. And the patent infringement also, as Mr. Tarang also explained earlier, we had a strong case to fight it out. We had certain legal opinions also supporting our case, but then again, to conclude the deal or to avoid further delay in the deal, we had to reach this out-of-court settlement and come out of these disputes. And then there were a few other adjustments like working capital changes on license costs and lease liabilities, which we had to correct. So that resulted in a reduction of equity value of about EUR 188 million. The escrow amount earlier pegged at EUR 35 million has now been brought down to EUR 28 million because the EUR 35 million earlier also had a Valeo related escrow of close to about EUR 10 million. Now that we reached a settlement, so that has gone out. And then similarly, the debt repayment is now EUR 33 million. Earlier it was EUR 62 million, but some of the debt has been repaid in the last few months. Now this is, again, a good relief for the continuing operations. So from the continued businesses, EUR 33 million of overseas debt is going to be paid out. So that will reduce the burden on continued operations. So that leaves us about EUR 5 million to EUR 9 million as the net cash accrual to us. Now all this will result in some kind of write-down or impairment of the investment in VCHBV. But this is under evaluation right now. We'll have to take into consideration various factors here because some of these VCHBV investments are into both continued and discontinued businesses. We are in the process of doing a fair value assessment of some of those continuing businesses because we will see where the net impact ends up, and anyway, we'll be completing audit by end of this month. So when we talk about the Q2 results, we'll explain what could be the net impact. So now I will take you to Slide #4. So this gives the status of net debt. Previously, I think when we talked about the net debt levels as of 30th June, we indicated that the continued operations in INR was INR 15.2 billion which will now come down to about INR 13 billion. So that's one good development. So that's about the deal and the impact on the overall debt levels. I'm talking about these continued operations. Of course, the things are looking bright for the existing businesses. We could actually improve profitability in Q1 for continued businesses. In fact, the momentum is continuing. Both in August and September also, we could record one of our highest ever revenues for Indian operations. Of course, we will see the -- and we'll talk about the full results when we talk about the Q2 final results. We also added 3 new customers, significant customers in the last 6 months in the EV business and the ramp-up of existing EV components business, which we obtained earlier is also happening. And then, of course, the new orders with a lifetime value of close to INR 1,500 crores have been won in Q1. Q2 status also will report later. The aftermarket business continues to grow healthy at 20%. Now one important thing we would like to bring to your notice going forward, we'll be focusing heavily on free cash flows and return on capital employed improvements. We'll be very prudent in our capital deployment strategies also. So in a way, I think this is like a new beginning for Varroc, the significant burden in terms of overseas operations and the cash flows has been now taken away. So it enables us to focus now on the existing businesses, which are profitable. So we'll be focusing on free cash flow generation going forward and see how to actually properly deploy it going forward. And we'll also be focusing significantly on integrating our remaining overseas VLS operations. So that will be our area of focus in the coming weeks and months. So with that, I will stop. We will now take your questions and clarify any doubts that you may have. Thank you.

[Operator Instructions] We have our first question from the line of Aditya Jhawar from Investec Capital.

Congratulations to the team for closing the deal in such a challenging time. I have 2 questions. Number one, on the debt side. So for the next couple of years, what is the line of sight of debt repayment? So if you can walk us through that, what could be the CapEx for continued operation? And what is the plan of debt repayment in FY '23 and FY '24.

So Aditya, whether debt is concerned, see now, I would say that the debt is under more manageable levels. We see very high growth in the Indian market in spite of what's happening in the rest of the world. India continues to grow and we're also growing in some of the important segments like EV and electronics and lightweighting. So this augurs well for us. So we are quite confident that over the next couple of years, we will be bringing this debt down considerably. And our focus, definitely, like what you correctly mentioned, will be in 2 areas. One is, of course, prudent capital allocation, and we do not see -- I'm talking now only about India and Europe. So we do not see that the CapEx going forward will be more than probably around INR 300 crores or a little bit more in that range. And whatever else, with the rising EBITDA, which we expect with the rising sales, we do -- we are going to focus that we have a quarterly reduction in our debt as we go along. So we're really focused on how we are managing to still become a net debt zero company going forward in the next couple of years.

Okay. Okay. Yes, that's helpful. My second question is that in our order wins specifically for EV components, have we got any visibility or order wins from other than Bajaj for EV-specific components?

So in this -- in the recent months, now we have 3, I would say, prominent EV players. They are the incumbent companies. We've got 3 large indi players where we have 1 business. We're not allowed to disclose the names and the details at the moment. We will try to see if we can share it with you at the time of the Q2 results. But we have now 3 companies, and things are looking very good for us going forward for the EV space, whether it's for the powertrain or whether it's for the other components in the EV.

We have our next question from the line of Abhishek Jain from Dolat Capital.

Sir, you mentioned that you -- after this deal, your debt would be reduced to the INR 13 billion. So how much is from the India continued operation and overseas continuing operations?

Yes. I would say that -- okay, please.

Yes, I'll take this question. See, most of it will be in India operations. There will be only very little left overseas.

So how much debt would be left in the overseas operation? Earlier in the last quarter, it was around INR 5.3 billion.

Yes, it will be in terms of INR equivalent, it will be close to about INR 100 crores.

INR 100 crores, okay. And after this deal, you will have a balance of around EUR 120 million. Out of that, you will pay around EUR 52 million. So net cash flow should be around EUR 70 million, and out of that EUR 30 million for the escrow accounts. So still you should have around EUR 40 million, and you were talking about the EUR 5 million to EUR 6 million only.

Yes, yes. So we are not counting on the escrow money now. So that's why these levels what we are indicating now is excluding the escrow realization.

So after excluding escrow realization, we have a calculation of that, you should have around EUR 50 million. Because you had paid around EUR 400 million as a debt. And so balance would be around EUR 120 million. And there are -- out of that, you will pay around EUR 52 million because of this Valeo litigation.

Yes I mean, I think we gave the details in the slide. We can see those details there. So what we are saying is, after all is the equity value will be close to around EUR 66 million to EUR 70 million. Out of that, if we take escrow of EUR 28 million out will be left with around EUR 42 million. Out of that, EUR 33 million will go to repay the continued operations over this debt of about EUR 33 million. So that leaves out anywhere between EUR 5 million to EUR 9 million for other things without counting on escrow.

Okay, sir. Got it. And sir, what is the future of the China VLS business after this deal? Most probably that will be scrapped because there won't be -- there will be competition with the other players also.

So see, on the China piece, as you know, that Plastic Omnium has not bought into our JV in China. So our JV is still continuing in China that is between the Taiwanian company TYC and us. We have been in discussions for the last couple of years for a split between us, and those discussions are progressing. We are hoping that we are able to reach a conclusion within this financial year '23 so that then we can also get the China operations, I would say within our continued operations going forward from the next financial year. So those discussions are going on for a split, and we are hoping to see some results there in the coming near future within this financial year.

Sir, because of this litigation to Valeo, is there any impact on the 4-wheeler India lighting business, which is getting a good business from the many OEMs?

No, not really. Because see personally, I mean, on this Valeo litigation, frankly, our case was very strong. But like Mahendra said, that we had to kind of reach the settlement in the interest of concluding on this deal. But what this means this is the total settlement, the settlement for the past any pet so-called alleged patent infringements. And also, we have a license for all the current products for the future till end of life. So this covers everything, and it includes also whatever are all the entities of Varroc, which are remaining with us, whether it's India or it's China or elsewhere, all are included under this future license.

And sir deal has completed on 1st October, you will not incur any further loss of VLS for the first half FY '23?

No. So we are not -- so as you know, that on the discontinued operations, that's not coming on in our results. So we are only kind of showing the results of the continued operation.

Okay. And sir one last question is what is your revenue target -- revenue and EBITDA target for FY '23 and debt repayment target for the next 2 years?

No, so basically, this year, for this financial year we already said that for the continued operations and not including China till it splits, we were looking at about INR 7,000 crores of revenue. And on the EBITDA side, I think we would be trying to achieve EBITDA of around 9%. And going forward, next year, obviously, we are looking at a growth like we have said that especially in India, we're looking for a growth -- and India now will be a main stay almost about 18% of revenues coming from India, and here, like we said that we will grow 10% more than the market growth in the Indian segment. And definitely going forward, I mean, we are also -- we are looking at double-digit EBITDA. But our target is, of course, going forward to be between 11% and 12% EBITDA in the next financial year for the whole of continued operations.

And debt repayment plans for this year and next year?

So we will see. That is something which we are actually working on our debt repayment schedule. So that's something we're working on. And we will see, like I said, quarterly reduction in debt as now we are in control. It will not go up is only that is going to reduce. That's something I think we can probably a little bit more share with you when we are announcing the Q2 results. But definitely, I think we'll be in a healthier space as we move along where debt is concerned. That's something which is also on top of our agenda.

Yes, Abhishek just don't take this speech as future guidance or any kind of revenue, the revenue guidance or profit guidance. These are like our estimates.

[Operator Instructions] We have our next question from the line of Jyoti Singh from Arihant Capital Markets Limited.

So my question is on the similar side of the debt. As we have debt around INR 50 crore, INR 53 crore in FY '22. And after this deal, how much we're expecting it will reduce by '23 and '24, if you can guide us.

Mahendra, do you want to?

Yes, so as I explained earlier in my presentation, after this deal, we will end up with a net debt of about INR 13 billion or around about INR 1,300 crores to INR 1,350 crores.

[Operator Instructions] We have our next question from the line of Karan Kokane from Ambit Capital.

So my first question is on growth. So you mentioned that you're planning to grow 10% ahead of the industry. So could you please elaborate on what would be the key drivers of this?

So the key drivers would be basically, I think the content growth, which is coming in the developed premium. See largely -- I'm talking now more in India, which will be a larger play. So in India, we see a lot of premiumization of -- in the 2-wheeler market. And there's a content growth, which is happening. For example, we see -- for example, like say, when it comes to Bajaj Auto, we have seen that the Pulsar family, just to give you an example, as we're saying that they were -- I mean, they had models between 125 cc to upto 250 cc in the Pulsar range. Now other than 125 cc, all the others, they've come out with new models, above 125 cc, which today approves codename K17, but it will be called something. And here, the premiumization is a lot. When it comes to electronics, when it comes to even the use of plastics, the use of paint in the plastics. So there's a lot of premiumization, which is already happening, for example. So a lot of that, a lot of the -- our listing entry into more of the 4-wheeler plastics business in India on the interior components side. And generally, obviously, the engine size growth will lead to a lot of additional business because when it comes to the scooters and 3-wheeler where we see more of engines happening, at least in our case, our share of overall listing is not more than 10%, 12% for scooters and on the 3-wheeler side. And here, whatever comes out of the EV side, it's all additional revenue for us and also a huge content growth for us. So therefore, we see that from a revenue standpoint, we can say that even if the market grows next year at 7% or whatever, 5% to 7%, we will be 10% more. We are very confident going forward that the revenues will be realized. And we have already won in this financial year, last financial a lot of business, when it comes to plastics, plastic products or related polymer products, electronics, lighting, 2-wheeler and 4-wheeler lighting. So we remain quite I would say, bullish over here. And also when it comes to our foreign 2-wheeler lighting business, where it comes to Italy and Vietnam. Vietnam, we see quite a good growth going forward. In Italy, yes, we have to get in some more revenue, now that's something now we will focus in a bigger way. And of course, the 4-wheeler electronics, which we have a plant in Romania, we will also see a certain level of focus coming in there. So I'm just saying that we -- on the back of India, we see a good level of growth. And what we're talking about 10% was more for the Indian market, not for Europe.