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VA Tech Wabag’s NCDs and Bank Loans’s Long-Term Rating to ‘IND AA-’/Stable; Rates Additional Limi...

Posted: 05 Feb 2025

VA Tech Wabag’s NCDs and Bank Loans’s Long-Term Rating to ‘IND AA-’/Stable; Rates Additional Limits Detailed Description of Key Rating Drivers Leading Player in Water Treatment Industry: VATW, a global leader in the water industry with over 100 years of experience, offers a complete range of technologies and services for total water solutions in both municipal and industrial sectors. It is present in all major segments of the water treatment industry, including drinking water, sewage, industrial, seawater desalination, and water recycling. Over the past three decades, VATW has delivered more than 1,400 municipal and industrial water treatment plants worldwide. The company places significant emphasis on research development (R&D), supported by dedicated R&D centres located in Europe and India, and holds over 125 intellectual property rights. With this technical expertise and annual revenue base of INR25,000 million-35,000 million, VATW is qualified to independently bid for most of the projects. Operating in multiple countries, the company derived approximately 46% of its 1HFY25 revenue from India and 54% from rest of the world. Healthy Revenue Visibility: During 1HFY25, the company secured projects amounting to about INR46.1 billion, leading to a strong order backlog of INR134.1 billion as on 30 September 2024 (FYE24: INR102.8 billion). This includes about INR79.5 billion of EPC and INR54.6 billion O&M contracts, maintaining a balance mix. The company also had framework contracts of INR11.9 billion during the same period. Furthermore, in the last three months ended December 2024, the company secured new EPC projects of about INR7 billion from Lusaka Water Supply and Sanitation Company, Zambia, INR1.5 billion from Chennai Petroleum Corporation Limited, India and O&M project of INR1.2 billion from BAPCO Refining B.S.C, Bahrain. The order book is concentrated with the top five projects accounting for about 55% of the total order book, including the largest project, Chennai Desalination project, which contributes about 33%. However, the company’s successful track record of executing similar projects in Chennai ensures minimal execution risk. On 16 December 2024, a tender for one of the large water desalination project from Saudi Arabia was terminated by the counterparty due to internal administrative procedure. Despite this, the company’s revenue visibility remains strong with the current EPC order book/EPC revenue of 2.75x in FY24 (FY23: 2.9x). Most of VATW’s projects are funded by central government agencies such as Namami Gange Mission, Atal Mission for Rejuvenation and Urban Transformation, and multilateral agencies, reducing any customer default risk. During FY20-FY24, the company’s liquidated damages averaged around only 0.4% of its revenue. Stable Revenue; Focus on Profitability: With the company’s continued focus on technology-driven projects with engineering and procurement as the scope of work, the operating profitability witnessed a continual improvement with the EBITDA margin (excluding other income) increasing to 13.2% (FY23: 10.7%; FY22: 8.0%). However, the revenue moderated to INR28.6 billion in FY24 (FY23: INR29.6 billion; FY22: INR29.8 billion), mainly on account of the divestment of three European subsidiaries. During 1HFY25, the company reported revenue of INR13.3 billion (1HFY24: INR12.2 billion), with an EBITDA margin of 13.6%. The EBITDA margin including benefits from forex fluctuation at 14.7% in 1HFY24. The agency draws comfort from the improving profit margins in the last few quarters (2QFY25: 13.4%; 1QFY25: 13.0%; 4QFY24: 12.4%) and the presence of price escalation in selected projects, which would negate the impact of commodity fluctuations to some extent. Moreover, the company’s emphasis on engineering and procurement project over EPC projects is likely to support the overall EBITDA margins, since the company subcontracts the construction activity of EPC projects, which carries negligible margins. Credit Metrics Likely to Remain Comfortable in FY24: The consolidated gross interest coverage (EBITDA/interest expenses) improved to 5.3x in FY24 (FY23: 4.8x), supported by an increase in the EBITDA to INR3.8 billion (INR3.2 billion). By 31 March 2024, the company had transitioned to a net debt free company (gross debt less unencumbered cash), with an outstanding gross debt of INR2.8 billion against free cash of INR3.8 billion. However, the gross debt increased to INR4.2 billion as on 30 September 2024, mainly due to higher short-term working capital borrowings. Despite this, the company remains net debt free with free cash improving to INR5.25 billion. Additionally, the company holds INR1.2 billion as margin money in escrow account or security against the borrowings, guarantees and other commitments. The consolidated net leverage (net debt including the letter of credit (LC) acceptances to EBITDA) and total outside liability (TOL)/EBITDA also improved to 0.8x in FY24 (FY23: 1.5x) and 7.3x (7.9x), respectively. Ind-Ra expects VATW’s order book to remain strong with steady project execution, which will support healthy operational performance in the near-to-medium term, ensuring the company maintains its strong credit metrics. Asset-Light Business, Equity Commitments in HAM projects: VATW operates as an asset light company, leveraging on its R&D capabilities and focusing on engineering and procurement aspects of the project, while subcontracting the machinery-intensive civil construction work to third parties. As on 31 March 2024, the gross carrying value of its property, plant and equipment stood at INR1.2 billion (net carrying value of INR0.7 billion) while managing a revenue scale of INR28.5 billion in FY24. Additionally, the company’s capex remained low at INR0.1 billion in FY24. The company has three HAM-based projects, wherein the aggregate equity requirement is around INR1.1 billion, against which it had already infused 98% as of 31 December 2024. The company expects to pare its share to 26% by inducting new investors in Ghaziabad HAM project, as it has already done in the Kolkata and Bihar HAM project. After completing three years post commercial operations, the company has the option to monetise these HAM investments. Elongated Working Capital Cycle: The payment process typically follows a milestone-based billing cycle, resulting in substantial funds being tied up as unbilled revenue. The construction period of the project usually has two-to-three years, followed by one-year defect liability period, causing a material retention money to remain locked until the defect liability period concludes. Furthermore, the company undertakes certain projects in consortium with civil contractors, where the final bill payment linked to plant commissioning, which in turn is contingent on the civil contractor's completion of work. As a result, the company’s receivable collection cycle remains elevated. During FY24, the receivable collection cycle (including trade receivables, retention money and unbilled revenue) elongated to 250 days in FY24 (FY23: 180 days). As per the management, more than 95% of the projects have strong payment securities and are backed by either LC or the central government/ multilateral agencies; hence, the risk of bad debt is minimal. The net working capital (gross working capital less payables and customer advances) as a percentage of revenue increased to 51% in FY24 (FY23: 43%) and working capital cycle to 98 days (81 days). Exposure to Cyclical Sector and Forex Risk: VATW is exposed to inherent cyclicality of the infrastructure sector and intense competition with several small players vying for tender-based contract awards. Furthermore, fluctuations in raw material prices adversely impact the profitability, although, this impact is partially mitigated through price escalation clauses in orders. Overseas contracts accounted for around 39% of VATW’s order book in 1HFY25, which exposes it to currency fluctuations; however, the risk is effectively managed through a combination of natural hedging and defined hedging policy. During FY24, VATW booked INR11 million of forex gains (FY23: INR369 million).