Harsha Engineers International Ltd Q1 FY2024 Concall Summary

Key Takeaways

• Subdued quarter, confident full-year view: Consolidated revenue was soft as European and Chinese markets dragged, while India stayed strong. Management still expects high single-digit FY24 topline growth and decent double-digit profitability.
• Subsidiaries are the margin story: Romania and China swung to losses on weak demand, semi-finished mix, and currency conversion hits, pulling consolidated gross margin to 44.8%. Both are expected to at least break even for the full year.
• Order book is building, not billing yet: The company absorbed significantly higher new orders in Q1, but the product development cycle means revenue materialization takes 6 months to develop and 1–2 years to mature.
• Large cages and Japan are the growth bets: Large size bearing cages grew 19% QoQ on outsourcing tailwinds, and Japan-based customer revenue jumped 20% QoQ with a strong pipeline.
• What to watch next quarter: Whether the promised H2 demand recovery in wind and auto actually shows up in Romania and China, and if the cost pass-through lag closes to lift margins back toward the 18% consolidated EBITDA target.

Consolidated Performance & Margin Walk

• Topline softness: Overall subdued performance driven by underperformance of subsidiaries and difficult market conditions in Europe and China; the Indian market continued to perform quite strongly.
• Gross margin compression: Consolidated gross margin fell to 44.8%, impacted by incremental sales of low-margin semi-finished castings in Europe, conversion losses on foreign subsidiaries' inventory from currency movements, a minor product mix shift, and raw material price increases not yet passed through.
• Exchange loss: A ₹2.42 crore exchange loss hit the P&L, driven by rupee depreciation and Chinese yuan appreciation. Consolidation rules require converting foreign subsidiary financials at average rates except balance sheet items, which impacted COGS via inventory conversion.
• Cost-side pressures: Raw material prices increased in the latter part of the quarter while selling prices softened, creating a pass-through reversal. Minimum wage implementation and higher power and fuel costs added further pressure.
• Employee cost: Q1 included a one-time wage increase that can be considered annualized. The company has started aggressive cost improvement projects and manual-to-auto conversion to rationalize manpower costs, with positive impact expected during the year but not visible in Q1.
• Power cost offset: The hybrid power plant benefit has started accruing. While real power consumption cost rose last year, the net level is almost flattish due to renewable energy benefit, though it does not cover 100% of internal consumption.
• Long-term margin ambition: Management targets a consolidated EBITDA of at least 18% over the next couple of years and a long-term gross margin around 50% on average.

Majmudar: "an indication that even on a consol basis, our target EBITDA is to reach at least 18% over next couple of years and I think we are working on that. We're pretty hopeful we should achieve it."

Subsidiary Deep Dive: Romania & China

• Romania performance: Semi-finished casting revenue was not too bad but carries very limited margins. Finished product revenues declined and were softer versus the previous quarter due to weak market conditions, particularly in wind energy where Romania focuses on larger-size cages.
• Romania business mix: Semi-finished business operates at single-digit EBITDA margin; the cage business targets 15%+ EBITDA margin. The blended medium-term target is 8%–9%.
• China performance: The market was very challenging in Q1. The primary loss came from conversion of inventory valuation due to exchange rate movements, though operational improvements were seen.
• China business mix: The cage business ideally delivers 15%–18% EBITDA margin, but the subsidiary also does trading, partially selling India products through the Chinese entity, which dilutes the overall margin. The blended target including traded business is 12%–14%.
• Full-year subsidiary outlook: Both Romania and China are expected to deliver positive EBITDA contribution this year; the internal target is at least breakeven if not better for both. Revenue is expected to be at best flat or show minor degrowth in FY24.
• Strategic rationale: The China and Romania plants are more strategic in nature. Their presence positions the company as an MNC player with multiple locations, helps de-risk the overall profile, and helps win more business in India, which is more profitable.

Majmudar: "the fact of the matter is that these acquisitions and these plants that we had set up in China first as a Greenfield and then as a brownfield, we are more strategic in the sense that because of their presence, our profile is actually of an MNC player having multiple locations. It helps us in de risking the overall profile of the company. Secondly, it helps us in getting more business in India, which is more profitable."

India & Export Momentum

• India domestic strength: The Indian market continues to perform quite strongly. The YoY decline in Q1 was due to commodity pricing differences: Q4 FY23 had higher pricing, while Q1 FY24 pricing was at a more comparable level, so volume terms showed decent growth.
• India growth outlook: India domestic revenue is expected to grow at mid-teens in FY24, definitely higher than 10%.
• India margin resilience: At the India level, the consistent 20%–21% margin demonstrated over many years will be maintained. Q1 provisioning and pass-through impact will normalize over the whole year. Standalone India Engineering EBITDA margin of 20%+ is sustainable.
• Export trajectory: Export growth is expected to be low to mid-single digits given the environment. The export mix out of India around 50%–52% seems maintainable.
• Medium-term growth conviction: The 15%–16% medium-to-long-term growth guidance still holds; management feels fairly confident of executing that, with very strong growth specifically in India.

Majmudar: "definitely, we see that holding and feeling fairly confident of that, executing that. Specifically within that, we are seeing a very strong growth in India basically."

Growth Vectors: Large Cages, Japan & Bronze Bushings

• Large size bearing cages: Witnessed strong growth of 19% in Q1 FY24 over Q4 FY23, capitalizing on an outsourcing opportunity. Management is very confident that in the next 1 or 2 years a significant shift will come from Japan-based customers.
• Japan-based customers: Strong traction with 20% growth in Q1 versus the previous quarter and a good pipeline. After 10–15 years of working with Japanese customers in Europe and the US, the company started supplying into Japan only 3–4 years ago. The last 1–1.5 years have been at an inflection point with the base increasing significantly.
• Japan wallet share: Current wallet share with Japanese customers is 2%–3%. The target of reaching 10% is a 3- to 5-year target, not 2–3 years as previously discussed. 20%–30% growth is expected to continue.
• Japanese customer dynamics: NKC, a Japan-based company, is the number one competitor within Japanese customers and has a very strong hold. The conversion process is relatively slow, but management is fairly confident of getting more business.
• Bronze bushing revival: Early signs of revival in demand are visible, with fresh orders coming in the current quarter and a positive forecast for the second half. The company is projecting about ₹45 crores of revenue for the year.

Rangwala: "they tend to be very slow. We started working with Japanese customer actually in Europe and US in last 10 to 15 years and only last 3-4 years back only we started supplying them into Japan. And this is relatively a slow process, but however, we think that we were last 1-1.5 years we have been at the inflection point"

End-Market & Sector Trends

Order Book & Pipeline

• Significant order absorption: The company absorbed significantly higher new orders in Q1. The order pipeline is very strong.
• Long realization cycle: New orders take 6 months to develop and 1–2 years to mature into full revenue. Confidence in H2 recovery comes from order wins 6–8 months back that are now materializing into revenue, though full potential takes 1–2 years.
• H2 recovery path: H2 is expected to be better than H1 based on customer indications. A partial recovery of roughly 7% QoQ is expected in Q2, driven by wind revival expectations, customer forecasts, and new order wins.
• Order inflow not quantified: Management declined to quantify the order inflow number, stating it would not be fair to disclose.

Rangwala: "just over last quarter we have actually absorbed significantly higher amount of new orders which considering our product development and realization cycle, it will take 6 months to develop and 1 to 2 years to mature"

Other Updates

• Greenfield project: Harsha Engineers Advantek Limited is in the final stage of concluding the land acquisition process. The CAPEX plan will be finalized in the coming months.
• US product liability claim: A potential issue informed about a year ago involved a claim recently raised by a customer but not paid. The company worked with the customer to address and resolve it and is now talking to insurance. Supply of the same cages has started regularly since the last 5–6 months. To the best of management's knowledge, this is the only outstanding liability of this nature and was already disclosed in the DRHP.
• No new product investigations: Management confirmed there are no new investigations or scrutiny following windmill failures at larger OEMs, only the historical recall claim from supplies between 2018–2021.
• European energy costs: Some softening has been seen in energy costs in Europe, contracted on a three-month basis. Costs should hopefully come down significantly in the next few quarters.

Guidance & Commitments

Key Metrics