Indian Railways New Wagon Allocation Scheme
India Ratings and Research (Ind-Ra) believes the new wagon allocation scheme, which was rolled out by the Indian Railways (IR) in FY19, would be a credit negative for the domestic wagon manufacturers, on account of the predatory pricing nature of the scheme along with higher working capital requirements.
Lower Revenue Visibility for Mid/SME Wagon Manufacturers; Decline in Industry-wide Margins:
In FY19, the IR allocated around 11,790 wagons with an overall order value of INR 34.2 billion to the domestic wagon manufacturers through the new Bucket Filling Scheme with a reverse auction mechanism. As per the revised scheme, the IR allocates wagons to L2-bidder at the same price as L1 only if the overall capacity of L1 is fulfilled, against the erstwhile mechanism where 60% of the tender quantity was allocated to L1-L6 bidders on a fixed ratio basis (13:12:11:10:8:6) and the rest 40% based on their remaining capacities and execution track records. The overall capacity of the respective players would be evaluated by a separate team under Research Design and Standards Organisation based on certain categories as specified in the tender document released by the IR at the time of the tender. The previous policy was implemented by the IR to allocate its orders to players operating across segments, while the new scheme would impact revenue visibility of the small/mid-sized corporates who have created capacities in this segment. This is majorly on account of the presence of larger players who would have better bidding capabilities to acquire the major chunk of orders, thus impacting the industry-wide average realisations backed by the reverse auction mechanism. Thus the impact would be larger in small/ mid-sized corporates on account of greater dependencies on the IR wagon allocations than the large players who have well-diversified order books.
Although the average price per wagon increased to INR2.9 million in FY19 from INR1.3 million in FY15, the increase was disproportionate to the expectation of the wagon players due to stoppage of free supply items by the IR. There are also instances in the previous allocations where some of the wagon players had expressed their dissent in executing the wagon allocations at the price quoted by L1 bidders, resulting in price revisions by the IR. Moreover, in 3QFY19, Texmaco Rail Engineering Pvt Ltd (Texmaco: ‘IND AA-’/Negative), despite having the largest unutilised capacities in the industry, availed only 1,623 wagons amounting to around INR5.0 billion as the other bidders had quoted far lesser prices, resulting in predatory pricing.
The Rise in Working Capital Requirement; Credit Negative for Industry:
The IR was providing free supply items, which accounted for 45%-50% of the overall raw material cost required to manufacture its wagon orders on timely basis till FY17, instead of mobilisation advances. However, in FY18-FY19 allocations, it stopped issuing these free supply items on account of supply constraints. Moreover, free supply items such as cartridge tapered roller bearings will have to be purchased from Research Design and Standards Organisation approved sources, steel items from integrated steel plants where the IR board was earlier procuring and wheel sets from Rail Wheel Factory located at Bangalore. Thus, the working capital borrowings for these wagon manufacturers have increased in the past few years to 35.4% of revenue in FY18.
Ind-Ra expects the working capital debt as a percentage of revenue across the sector to have increased further in FY19 and will continue to rise inFY20 as around 33% of the orders released by the IR in FY19 are likely to be executed by the end of June 2019 and the remaining by February 2020 as per the tender document. This is reflected in the incremental working capital requirement of the largest domestic wagon manufacturers Titagarh Wagons Limited (‘IND A-’/Negative) with the average fund-based utilisation of around 96% (FY18: 46%) and Texmaco with utilisation of around 90% in FY19. These wagon players are looking to tie up new working capital facilities to accommodate the additional requirements and any delays in tying up their required facilities may hamper their execution capabilities. Ind-Ra expects lower-than-expected realisations, coupled with the increase in working capital utilisation levels would impact the credit profiles of the domestic wagon players negatively in FY20.
Increase in IR Budgets Not Transforming to Incremental Wagon Allocations Result in Industry-wide Lower Capacity Utilisations:
Although the IR budget allocations increased at a CAGR of around 15% to INR1,480 billion in FY09-FY19, the wagon additions were inconsistent. Moreover, in FY12, FY13, FY14 and FY16, the IR did not allocate any wagon orders resulted in market disruptions in small and mid-corporate segments, whereas the larger players accommodated their order book with private wagon orders.
Although the concentration towards the IR orders has declined over the years, the dependency to sustain the operational costs still persists with the IR as the wagon business operates with higher fixed costs such as employee, labour, administrative and other related expenses accounting 25%-30% of the overall costs, along with the front-loaded capex which the players have put in the past few years. The lower-than-expected capacity utilisation led to poorly fixed cost absorptions and the consequent low margins and ceased new capacity build up in the past few years, leading to almost stagnant capacities.
Though IR released around 11,790 wagons of the overall 22,000 wagon requirement in FY19, the pending 9,000 wagons would be released in FY20, Ind-Ra believes the capacity utilisation to remain subdued at the existing levels in FY20-FY21, on account of the lower realisations and higher working capital requirements. However, with the commencement of Dedicated Freight Corridors, both Eastern and Western scheduled in the next two-to-three years, the wagon requirement is likely to increase and result in better revenue visibility for the wagon manufacturers, thereby increasing industry-wide operational efficiencies.
Road Ahead: In the past few years, the domestic wagon manufacturers have either diversified their order book or filed insolvencies on account of the issues persistent in the wagon industry. However, market leaders such as TWL and Texmaco chose different paths to diversify their order books; TWL ventured into foreign operations by acquiring entities majorly in Europe, while Texmaco acquired entities in the rail EPC segment to reduce the concentration risk from the IR wagon segment. These entities have availed the required pre-qualification status to venture into other business verticals such as electrification, metro operations, etc., which offer better realisations along with diversified order book. Considering the inconsistencies in the IR wagon orders in the past decade coupled with the incremental working capital requirements and the supply chain challenges in the wagon industry, Ind-Ra believes these issues would lead to further consolidations among the players in FY20-FY21.
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