MANAGEMENT DISCUSSION AND ANALYSIS

Global Economy and India

The year 2015 was a quiet year for global Economy. As per the estimates of the leading global agencies, the world economy is likely to have grown in the range of 2.3%-2.5% as compared to the forecasts of 3% a year ago. Despite the lower commodity prices, the growth was muted on account of demand deficiency and excess global supply. The growth rates have also been disappointing for emerging markets that not only witnessed demand issues, but also went through currency debrciation (against USD) and capital flight from them to eveloped markets. Also, a faster-than-expected slowdown in imports and exports reflected weakness in manufacturing activity. These developments had spill overs to almost every nation through trade channels, resulting in diminishing confidence and  increasing volatility in financial markets. The Manufacturing activity and trade stayed weak  globally and the demand also remained subdued As per IMF, the growth in emerging market and  Elecon Engineering Company Limited  56th Annual Report 2015 -16 developing economies is projected to increase from 4% in 2015 to 4.3% and 4.7% in 2016 and 2017, respectively. Growth in many countries is expected to slow down in 2016 and 2017, primarily reflecting weaker investment growth as the economies continues to rebalance.

From an Indian Perspective, India's growth slowdown appears to have bottomed. India is projected to continue growing at a robust pace. The government has front loaded capital expenditure to help drive economic activity with a focus on infrastructure-based-sectors which tend to have a multiplier effect on the economy.

The growth should continue to steadily improve in 2016 and is likely to be led by public sector capex and urban consumption. The improvement in India's economic fundamentals coupled with strong government reforms, RBI's inflation focus supported by benign global commodity prices should take India to its target growth. The steps taken by the government in recent times have shown positive results as India's gross domestic product (GDP) at factor cost at constant (2011-12) prices 2014-15 is Rs.106.4 trillion (USD 1.596 trillion), as against Rs.99.21 trillion (USD 1.488 trillion) in 2013-14, registering a growth rate of 7.3%.

The Indian Engineering sector has witnessed a remarkable growth over the last few years driven by increased investments in infrastructure and industrial production. The engineering sector, being closely associated with the manufacturing and infrastructure sectors, is of strategic importance to India's economy. The capital goods & engineering turnover in India is expected to reach USD 125.4 billion by FY 17. Comparative advantage in terms of manufacturing costs, market knowledge, technology and creativity has been a driving force for engineering exports from India. Engineering exports from India stood at USD 70.6

billion in FY 15, registering a Compound Annual Growth Rate (CAGR) of 11.1% over FY 08-15.  Capacity creation in sectors like infrastructure, power, mining, oil & gas, refinery, steel, automotives, cement, ports and consumer durables has been driving demand in the engineering sector. Separately, the approval of significant  number of Special Economic Zones (SEZs across the country and the development of the Delhi Mumbai Industrial Corridor (DMIC) across seven states is expected to further bolster the engineering sector. With 100 per cent Foreign Direct Investment (FDI) allowed through the automatic route, and initiatives like 'Make in India', major international players have entered the Indian engineering sector due to significant growth opportunities available.

In the gears segment, the global demand for gears and gear assemblies is forecasted to reach USD 217.0 billion by 2018. Market gains will be driven by ongoing economic growth, increased manufacturing output and a shift in the product mix towards more energy efficiency. Strong demand in relatively small but fast-growing markets like wind and solar energy will also contribute to gear sales advances. Demand in developing parts of Asia, Eastern Europe, the Africa/ Mideast region and Central and South America will outpace product sales in the United States, Western Europe and Japan. Demand for gears used in all other applications; which include everything from aircraft and home appliances to solar energy systems. Advances will be driven by growth in global economic activity and higher income levels, boosting demand for a number of gear-containing products.

Elecon Engineering - Company Review

Elecon Engineering closed FY 16 on a mixed operating performance. While the year was challenging from a business point of view, the Company made significant headway in terms of order booking and sustaining operational activity at the plant level.

On the business front, The Company's gears business continued its robust performance of order booking and execution. It also booked two very large scale orders in the naval defence space. The gear business's standalone order book now is about Rs.72,200 Lacs.

These were the brstigious orders for Elecon given the strategic importance of the defence sector in India. This is also a testament to the new range of marine gearboxes which the Elecon R & D team had introduced to the market in FY 15. In the Navy business, the Company is dominantly placed and with the defence plans that the country has, it gives a very healthy outlook towards the business

The Material Handling business, however, remains sluggish owing to macro factors which the Company believe would be taken care of by the government's ongoing measures across sectors. This seems to be an industry level issue as the year saw less number of projects in the market for tender. The Company had a reasonable order inflow, however execution at the level of client resulted in muted financial performance. However, as a counter measure and for the long term gain, we have already turned our strategy more towards our product business and less on the EPC terms. When we look at topline in MHE around 25-30% was contributed from EPC business and 70-75% came from Products and going forward, we envisage EPC business to go down further and the product business will keep on increasing.

Further, The Board of Directors of the Company have unanimously recommended the proposed combination of Elecon Engineering Company Limited with Elecon EPC Projects Limited. The merger of Elecon EPC into Elecon was necessitated as some of the advantages that we envisaged in the earlier demerger of 2012 did not percolate down to both the divisions. While the Company did see some momentum in the gear business, the material handling business was down due to multiple factors beyond company's control. The Company believes that merger of the Material Handling business back into Elecon Engineering would deliver economies of scale and financial benefits that would benefit both the Company and the shareholders.

At the close of FY 2015-16, the Company's gear business order book stood at Rs.72,200 Lacs while the MHE business's order backlog translates to about Rs. 84,100 Lacs. The gear business orders generally take 3-9 months in execution (excluding the recent naval orders) while the MHE orders could take more than 12-24 months. This gives the Company a strong order book visibility for the coming period.

Segment Wise Revenue - Gear Business

During the fiscal 2016, the power business contributed close to 28% in the overall business. In terms of orders, the sector however did not contribute significantly. There have been less orders that were floated in the market in this particular sector. Going forward, Indian power sector is likely to undergo a significant change that has redefined the industry outlook. The Government of India's focus on attaining 'Power for All' has accelerated capacity addition in the country. The Planning Commission's 12th Five-Year Plan estimates total domestic energy production to reach 669.6 million tonnes of oil equivalent (MTOE) by 2016-17 and 844 MTOE by 2021-22. By 2030-35, energy demand in India is projected to be the highest among all countries according to the 2014 energy outlook report by British oil giant, BP. Around 293 global and domestic companies have committed to generate 266 GW of solar, wind, mini-hydel and biomass-based power in India over the next

Figure 3- Segment Wise Breakup of our gear business

5-10 years. The initiative would entail an investment of about USD 310-350 billion. Our business in Cement sector was 9% of the overall revenues. The sector's demand was also subdued as the capex activity in the sector has not really picked up to its full potential. We booked close to 4,000 Lacs of orders in the sector. However, we envisage this sector to remain important for us and in the future we are hopeful of ground level recovery in the economy. The Cement demand in India is expected to increase due to government's push for large infrastructure projects, leading to 45 million tonnes of cement needed in the next three to four years. India's cement demand is expected to reach 550-600 million tonnes per annum (MTPA) by 2025. The housing sector is the biggest demand driver of cement, accounting for about 67% of the total consumption in India. The other major consumers of cement include infrastructure at 13%, commercial construction at 11% and industrial construction at 9%. The other sectors which contributed to our revenues were sugar, steel, chemicals and marine. In the steel sector, we envisage structural changes that would positively impact the sector. The growth in the Indian steel sector has been driven by domestic availability of raw materials such as iron ore and cost-effective labour. Consequently, the steel sector has been a major contributor to India's manufacturing output. India's steel consumption for FY 2015-16 is estimated to increase by 7%, higher than 2% growth last year, due to improving economic activity, as per E&Y's 'Global Steel 2015-16' report. From an order book perspective, as we mentioned earlier, our major contributor has been the order worth Rs.53,000 Lacs received in the marine defence space.

We are hopeful of this business seeing more traction in the years to come. From a port and shipping industry perspective, the Ministry for Shipping, Road Transport and Highways announced a massive investment in India's ports and roads sector, which is likely to help boost the country's economy. The Indian government plans to develop 10 coastal economic regions as part of plans to revive the country's Sagarmala (string of ports) project. The Government plans to invest Rs.70,00,000 Lacs (USD 10.5 billion) in 12 major ports in the next five years under 'Sagarmala' initiative.

Financial Performance

From a financial perspective, the standalone total turnover remained muted at Rs.51,884.38 Lacs as compared to Rs.50,319.24 Lacs in the brvious year. EBITDA stood at Rs.10,467.42 Lacs as compared to Rs.10,650.35 Lacs during the brvious year. EBITDA Margin at 20.2% for FY16.Net profit stood at Rs.4,315.20 Lacs for FY16 as compared to Rs.3,318.58 Lacs in the brvious year, an increase of 30%. Basic EPS stood at Rs.3.96 as against Rs.3.05 in FY15, an increase of 30%. At the Consolidated level, the turnover were Rs.1,28,534.56 Lacs this fiscal as compared to Rs.1,32,889.05 Lacs in the brvious year. This decline was largely on account of drop in the sales of our material handling business. At the EBITDA levels, it registered a margin of 11.7% and the Consolidated PAT after minority interest and share of profit of associates was at Rs.3,821.67 Lacs. This also includes the sale of surplus land which we concluded in the third quarter of fiscal 2016.

The Board of Directors of the Company also recommended a dividend of 55% (Rs.1.10 per share) for its shareholders.

Risk and Concerns

As far as the industry, in which your Company does its business, is concerned, the significant challenges to gear business included high cost brssure from customers to reduce investment costs, quick response times for quotations, technology upgrades, lack of skilled labour, material costs, the overall economy and supply chain issues. However, the increase in capital expenditure for vendors also could pose a challenge to the growth of this market.

However, your Company has surpassed all the internal challenges like, technology upgrades, lack of skilled labour, supply chain, etc. to continue the momentum in business operations. The external challenges can be met as economic reforms will get in placed because of a stable government.

As your Company caters to various industries like, Power, Steel, Cement, Sugar, Ports, Mining, etc., it can maintain growth momentum by setting off slowdown of one sector with growth of the other in different industries, if in case the capex in each of the sector, being interest rate sensitive, is deferred in the current high interest rate regime.

Internal Control System

Internal Controls are continuously evaluated by the Internal Auditors and Management. Findings from internal audits are reviewed by the Management and by the Audit Committee and corrective actions and controls have been put in place wherever necessary. Scope of work of Internal Auditors covers review of controls on accounting, statutory and other compliances and operational areas in addition to reviews relating to efficiency and economy in operations.

Development in Human Resources/Industrial front

It has been the tradition of the Company to maintain excellent industrial relations at all levels. This has ensured a very healthy level of enthusiasm within the employees. This has enabled the Company to maintain its growth despite competition and economic slowdown.

The number of employees as on March 31, 2016 was 694 as against 638 as on March 31, 2015.

Outlook

The Indian Economic growth is projected to remain robust in the years to come. The Public investment has picked up and we also envisage faster clearance of key projects; better infrastructure and greater ease of doing business. We believe that the government's fiscal policy will remain supportive and investments in the energy, transport, infrastructure and core areas would be promoted. Going into the future, with the merger of two entities, the consolidated Elecon entity would be able to utilize its full potential and leverage on the combined financial strength as well as optimize the use of resources for the purpose of future growth.

The Company remains confident on the prospects of the business however an upside to its performance would directly correlate to the way overall economy performs. If the overall capex activity picks up in India, the Company may have a quicker translation of orders into sales and thus a better performance. For Elecon, the key catalysts to a better performance would be an increased economic activity including the revival of core sectors such as power, steel, cement and mining. The Company believes that the government is taking effective measures to take care of economic activity revival. Sooner than later, it should see the momentum coming back in the economy.