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Finolex Industries - Long Term Compounding Story

Background

CMP â 292 - Market Capitalization - 3636 cr

Part of the Finolex Group. Manufacturer of PVC Resin, PVC pipes and fittings. Till 2008, this was primarily a PVC resin manufacturer. Management however realized that the real money was in the end product and has gradually shifted to becoming Indiaâs largest manufacturer of PVC Pipes.

Change in management guard from father to son â also led to a fresh wave of thinking and the debt that was weighing down the balance sheet has significantly gone down in the last few years and if the management is to be believed â it will be a debt free company in 2 to 3 years.

Revenue Growth: India still has a long way to go in irrigation and there is significant potential opportunity for this company to expand it revenue. Though it is not expected to post scorching growth rates â but it still expects to compound revenues at 15-20% for the next 5 years. They have set up a new warehouse in Orissa and are aggressively targeting the North East region for growth.

Moat: Their distribution of network of 15000+dealers and a strong brand which allows them to command premium pricing for their products.

Improving Margins: As they have steadily moved from resins to PVC pipes and now PVC pipe fittings â the margins earned by the company are continuously improving. EDC â one of its key RM will be seeing significant capacity addition particularly in North America due to the Shale oil boom. This is expected to reduce the EDC prices and thereby improve the margins for the company. Fittings are also a very high margin product and their introduction to the mix is expected to add to the margin expansion in the upcoming years.

New Products: The company announced a few months back that they will be entering the water business - particularly water supply equipment and water filters. This is currently under planning stage and they expect to launch this perhaps in Q4 â FY16 or Q1 FY 17. According to a report issued by Barclays in July last year current market size of water supply and sanitation is $6 million and is expected to grow by $10-12 billion by 2016-2017 according to Planning commission estimates.

This is a market with significant competition and thus their forays in this venture will need to be closely followed.

Free Cash Flow Generation: They work on advances from the dealers (similar to Atul auto ??) and thus their cash flow generation seems pretty good. Cash flow from operations for last 2 years is averaging 250 crores a year.

Debt Repayment: They have also paid down debt of roughly 600 crores in last couple of years. Debt on FY14 balance sheet is 636 crores.

Black Swans â what can go wrong: Since RM is imported â exposure to foreign currency fluctuations is a significant risk. They have however began hedging their exposure recently.

Cheaper Imports ? Not at present â but cannot rule out completely. It though has the advantage of manufacturing its own resin.

Water Supply Foray â This could go wrong and damage future FCF generation.

Valuations

At current CMP of 293 â it is available at a TTM PE of 19.

Couple of important observations: The company owns 14% in Finolex Cables which is worth 550crs at CMP. The company also owns industrial land at Chinchwad, Pune. Though various values have been quoted in different articles âon an average â this land is worth 500-600 crores. They have been actively trying to sell this for last 4-5 years â but havent managed to do so yet.

If we take these two aspects into consideration â we are getting the operating business at approximately 2500 crores.

Not to forget a dividend yield of 2% at CMP.

Other PVC pipe manufacturers like Supreme, Astral enjoy much better PE multiples. If the debt hangover goes away and margins further improve, there is also a chance for PE rerating. However even without such rerating â it appears to be good candidate for compounding in my view.

Though its not a bargain price â is it a good business at a fair price?

It appears imho to be a stock which can be a steady long term compounder with reasonable downside protection.

Views invited to poke the bubble and feel free to raise as many doubts or questions.

Disc â Invested and you may assume that I am biased in its favour. :)

Financial Snapshot for last 3 years (figures in crores)


Mar-12
Mar 13
Mar-14 TTM
Sales 2099.78 2144.82 2453.03 2548.21
Op Margins
10.32% 12.25%
16.17% 15.10%
Net Profit
75.15 136.14 170.15 183.99
Div Payout
41.50% 42% 42.37%

My personal take…i might be wrong…Finolex is doing everything right as of now…

they improved their OPM, their bottom line,venturing into new areas which have potential growth…Its a matter of time the sales should improve as of now sales is not showing great progress in terms of numbers. So it is getting quoted at a lower PE. It might continue to quote at a lower PE till market gets to see some growth in terms of sales and profit. So if i am in your place i would accumlate slowly with a strict stop loss.

I’ve come to realize that markets are right half of the times, and more specifically when it assigns a lower multiple to a company compared to its peers.

You need to dig why Finolex has lower ROE despite lower working capital requirements, the management background and their mistakes, how did the mgmt act on these mistakes, the advantages and disadvantages of backward integration etc and you will get many answers on why the company trades at lower valuations compared to Supreme and Astral. I also encourage you to hear some conference call to get a sense of management thought process. It certainly has some moats but not the sustainability to keep these moats or even better grow these moats.

Given the bull market, the company may very well catch up in valuations with its peers. That is typically the nature of bull market as people start fishing for 2nd, 3rd grade companies as they trade at lower multiples and pushing up the prices. Think about margin of safety which is more than just the gap in valuations.

Disc: No holdings. I used to hold it but have exited few weeks ago.

1 Like

Hi Punit… you raise quite a few valid questions.

this article below can perhaps answer many of your questions much better than I may be able to articulate

http://www.outlookbusiness.com/printarticle.aspx?291898

However your question about sustainability of moat and ability to grow it has be intrigued and I will do some more digging into it.

Highlights of the Concall by Capital Mkt
Net sales decreased 4.4% on a y-o-y basis to Rs 633.4 crore for Q1FY’16 while EBITDA before exceptional items increased 1.3% to Rs 12.74 crore. EBITDA after exceptional items increased 16.6% to Rs 12.74 crore. PBT was up 42.5% to Rs 10.19 crore. PAT increased 40% to Rs 7.03 crore.The sales volumes for PVC resins improved by 13% to YoY to 63030 tonnes and PVC pipes and fittings was almost flat at 57967 tonne in Q1FY16.Average PVC resins realizations fell 11.1% to Rs 65831 per tonne in Q1FY’16 compared to Q1FY’15 while average PVC pipes and fitting realizations fell 5.6% to Rs 87892 per tonne. Realizations were lower on the back of fall in market prices.Raw material cost as a percentage to sales is lower by 300 bps YoY to 65%.EBITDA margin of the company was up to 20.11% in Q1FY’16 compared to 18.98% in Q1FY’15 and 9.74% in Q4FY’15. Margins improvement was led by focus on increasing sales of higher margins products viz. fittings, column pipes CPVC pipes.
The company is taking initiatives to scale up share of fittings in sales mix to over 10% from 6-7% currently.The company is increasing installed capacities of PVC pipes and fittings to 280000 tonne in FY’16 and 310000 tonne in FY’16 from 250000 tonne in FY’16. No capacity expansion is likely to take place in PVC resins.The company expects that share of organized players to rise further with GST implementation.
The company added 97 dealers pan India during the quarter. Management plans to further ramp-up its existing distribution network. At present, their distribution network consists of 15,000 dealers, along with the recently established three new warehouses in Cuttack, Noida and Indore. The management plans to add four more warehouses in FY16.The company expects double-digit volume growth in pipes and fittings in FY16. CPVC pipes registered positive growth, but on a lower base.Inventory gains were to the tune of Rs 15 crore in 1QFY16. The company benefitted from low-cost inventory carried forward from 4QFY15.
The management expects a debt reduction of Rs 100-200 crore in FY16.Power and fuel cost declined in 1QFY16 due to lower naphtha prices

Finolex join hands with Lubrizol.

Excerpts from Feb 2017 Interview: Overall good triggers for growth

  • Our non-agri biz will grow from 30% to 50% in next 5 years: Prakash Chhabria of Finolex
  • Capex spend Rs 30-40 crore a year and in coming two years, we are going to bump it up to Rs 75 crore
  • CPVC vertical to grow from 3 to 10%
  • FY18 CPVC pipes sales of about Rs 100 crore and want to take it up to Rs 200-250 crore in the next year
  • non-agri space is about 30 moving to 50 per cent in the next four-five years
  • non-agri has double the current margins
  • on Lubrizol Tie up : We will be manufacturing CPVC all the three locations in Baroda, Poona and Ratnagiri
  • Our time and energy will now be spent on developing the non-agri business faster and better while retaining the Agri business

Read more at:

Did anyone attend the conference call, any key takeways?

HDFC Securities Research Report: http://www.hdfcsec.com/Research/ResearchDetails.aspx?report_id=3022510

key branded player which has 19% market share in the organized segment of 60% of pvc pipes. of the total addressable market of 1800k MT- Finolex has 280k MT capacity and volumes of 145k lakh MT- Supreme has 400k Mt capacity and volumes of 235kMt. With consequent two good monsoons hopefully and with govt. impetus for housing segment and GST implementation will lead to good tailwinds to the pvc pipes industry. Finolex also has captive PVC resin production which leads to good backward integration. Now with their tieup with lubrizol in feb 17, they have entered into the CPVC segment which has higher margins. Though currently at 4k MT they are planning to ramp up the volumes to 50k MT in 4 yrs. Also for pvc segment they are planning to add up 150k MT in three years for which they have earmarked 300 crores from internal accruals.

Regarding the rawmaterial (EDC,VC,Ethylene) part which constitute nearly 65-70% of sales, are mostly imported. The raw materials as they are derivatives of crude are at low prices leading onto improved margins for the industry. Regarding the raw material cost and the PVC EDC spread are cyclical the company doesnt have any control over that. The management improves the margins by value added prodcuts like fittings and other higher margin products. Also they have cash and carry model for pvc pipes leading on to low receivables period an exception for lubrizol products which they plan to give 30 day credit.

Finolex is a very dominant brand in the agri rural space and they are planning to use that leverage for the cpvc pipes too. The current composition of sales is 70% agri and 30% non agri, the management plans to increase the non agri to 50% as it have better margins.

Overall though still a commodity play with a sustained low crude levels and gross margins of 30% and shift from unorganized to organized sector play, they have good tailwinds going forward. Lubrizol tie up for CPVC lends some more branded high margin products to its kitty. But supreme industries has higher return on equity due to higher NFAT and higher leveraging. Despite higher NPM compared to supreme industries due to good product mix they got to sweat their assets more.

at pe ratio of 22 and earning yield of 6.7% it remains to be at undervalued in comparison to peer with supreme at 40 pe and astral at pe of 60.

5 Likes

Started buying this for the following reasons (the merits of the business are already known to most people, hence will focus only on those details that are not very apparent without a detailed look) -

  1. Volume growth of 10%+ easily doable over the medium term - If one sees the data for the piping segment over the past 10 years, 10%+ vol growth has been happening in the PVC while the growth in the CPVC segment is much higher

  2. Realization growth has been in excess of 5% over the past 7-8 years, FIL clocks in the 1.04 lakh per MT range while Supreme is at close to 1.15L and Astral does close to 1.45L per MT. This obviously is a reflection of the product portfolio with fittings forming a higher % of revenue for the CPVC segment. The scope for realization growth for FIL is max among all listed players due to their traditional focus on agri segment where fittings do not play a large role. On a conservative note once can expect a 2-3% increase in realization due to favorable mix in products going forward (Mgmt wants to get 50% from non agri which includes the focus on fittings and the CPVC tie up with Lubrizol)

  3. Volatility in margins will keep reducing as in house consumption of PVC resin increases. Company will be adding 150,000 MT in PVC pipes while no capex is planned in PVC resin, looks like all resin will be consumed in house by 2020 (though company may trade some part based on economics). The business model is pivoting to a B2C from B2B which will make this a more secular business going forward, crude fall in 2015-16 made a huge dent on margins while the cycle has played out in their favor in 2016 and 17. EBITDA margins for 2016 and 2017 are very high due to favorable PVC EDC spread. Of course management has no control on this but the prospect of variability in margins and inventory loss will reduce further more from here

  4. Very strong moat (in my opinion) which reflects in the sale on cash model. WC needs to scale up sales from here will be minimal even if they hit their target of 50,000 MT from CPVC in 3 years. The quality of the business can also be gleamed from the fact that the core ROCE and ROE are in excess of 30% (once the capital employed and net worth are adjusted for the cross holding in Finolex Cables)

  5. Management is now focusing on top line growth - evident from the tie up with Lubrizol announced in 2017, aggressive capex plans (by their historical track record) and the increasing spends on ASP. The FX derivatives mistake is a thing of the past which made the business results look worse than they were between 2009 and 2013. One can see a similar trend in Finolex Cables as well. To summarize management has learnt from their past mistakes and have shown tangible differences in the way they are running things

  6. Very strong FCF generation which reflects in the dividend payout ratio in excess of 40% over the years. All capex needs can be met through internal accruals, this balance sheet is already debt free

If one does the math and puts the thesis together there is a strong possibility that the business can grow at 15% while bringing down the variability in margins with very strong free cash flow generation. At the current valuation, once adjusted for the 14.5% holding in Finolex Cables (which is also a strong moat business that appears to be getting to a different trajectory), the core business is available at a fwd multiple of 17-18, OCF yield of 5.5%+ and a FCF yield of 4%. While this may not scream undervaluation, from the current price I do not think too many things can go wrong and one can benefit a lot from any of the positive scenarios manifesting (volume growth closer to 15% for a couple of years, realization increase in line with historical average of 5% and PVC EDC spreads continuing to be favorable, continued strong performance by Finolex Cables which should make this entity more valuable automatically).

The healthy increase in the piping segment will not translate into corresponding increase at company level since the PVC resin external sales will continue to degrow till 2020. There on the top line increase is likely to be 12%+ over the medium term. I do not think any of these can be understood with a superficial look at the financials.

I would obviously love to buy this at 10% lower than the current level (which is where I got in my initial chunk before this ran up) but for stories with such potential and lower risk one should not be too picky about the entry level. My hypothesis is not based on a re rating from here, I believe earnings growth and strong cash flow generation will make this a 20% kind of compounder over the medium term.

At current market cap I think this one will at least match the returns from Astral Poly if not beat that. I actually see similar risks in Astral after they started making their own compound, I think the current pricing of FIL vis a vis Astral is an anomaly that will correct over a period of time. For the time being this story appears to be very under rated if not visibly under valued in an absolute sense - in a relative sense this is unbelievably undervalued compared to Astral (one is more or less paying the same price for both businesses though the profit of FIL is more than 2X the profit of Astral and one also gets to hold 14.5% in Finolex Cables!).

12 Likes

Zygo…Good write up…I also believe in the story of Finolex industries

Q2 FY18 concal. My notes -

  • Q4/Q1 are big qtrs for this company whereas Q2/Q3 are slower.
  • PVC prices usually go down from Nov/Dec till January. Yearly phenomenon.
  • Looking for very aggressive volume growth. Discounts will continue even in H2 this year. So margins may remain suppressed.
  • PVC business maintenance shutdown happens every 2-3 years.
  • CPVC division (850 SKUs/850 dealers). CPVC pipe volume qoq moved from 900 to 1200 and in case of fittings from 126 tonnes to 247 tonnes.
  • Capex of 250 cr (120 cr already incurred). Full impact for this will be seen in 2019-2020.
  • Pipe utilization @70/75%.
  • 1 billion USD target for 2020 is an optimistic guidance.
  • Average PVC/EDC spread in Q2 was 737 and now it is close to 700 (As on Nov 14th).

Reasons for lower EBITDA-

  1. The PVC resin plant was under planned maintenance shutdown for about 3 weeks in Q2 FY18 resulting in lower production as compared to Q2 FY17, though sales including captive were almost the same as the inventory was reduced. The total impact of this was about 6 Cr. During Q2 FY18 18% of production was through the VCM route compared to 3% during Q2 FY17, which resulted in higher RM cost.

  2. PVC EDC spread was also lower compared to Q2 FY17 and the impact was about 12 cr.

  3. The captive power plant was also shut due to maintenance. Impact ¬ 6.5 cr.

  4. The pipes and fittings was down ¬11.5 cr and this is basically because the moderation in the sales realization for the pipes and fittings continued during Q2 FY18.

My take -
Mgmt insisted pipe demand has recovered very well post GST but to me it looks like GST has been a spoilsport as far as margins are concerned. Some of it is due to shutdowns, but majority of it has been due to higher RM prices and discounts. Mgmt said they are trying to play the volume game to utilize additional capacity and thus have to offer discounts. If the demand is good, one does not need to offer discount to push extra sales in my opinion. Volume growth led by higher realizations should result in improved profits. On the contrary, margins have plummeted in this qtr. Regarding margin deterioration in PVC resins, that is owing to spreads and higher RM.

This looks like a good story as far as volume growth is concerned. But mgmt didn’t offer any guidance whatsoever regarding EBITDA/margins, etc. Crude dependence is heavy and sharp fluctuations can make/break the bottomline.

5 Likes

Hard to understand the strategy here:
Last quarter they couldn’t pass through the PVC price drop. What kind of pricing power does this company have?

All realization related questions have been dodged in this interview

There are sectoral tail winds:

Unorganized to organized price difference dropped from 40% to 15%
Agriculture ( where they are the leaders) likely to do well with favourable monsoons and loan waivers already given and more likely to come with elections nearing

Profits sliding despite these tailwinds.

1 billion usd was just aspirations, no plans to get there?

Two good things were volume growth and doubling of capacity in near term.

Very mixed up

1 Like

Recently I could speak with senior sales person from finolex for few min. As per discussion Finolex Agri pipe business has growth of around 30% at his regional office level. He said this was pretty much same across southern States.
Cpvc pipe growth was around 60to 70% but not to consider it because of their low base. Have been training plumbers with regular meetings. 4 meetings held in last 3months and trained around 100-125 plumbers per meet. Cannot comment/aware on margins. Not giving any extra discount to push sales except regular discount to dealers. Main competition in his area is from Astral and ashirvad. He is not aware of any pvc - edc spread /expected company margins. Only few large preexisting dealers have been given credit of one month for cpvc business otherwise it’s cash and carry.
invested.

2 Likes

Yawning difference between perception and value…so true …
On a cursory glance Finolex is flushed with cash… Even if it has to grow at scorching pace it has enough cash to fund it… Just because it is having a sales cagr of 7% in past 5 yrs markets valuing astral which is not as cash rich as finolex more than market cap of finolex( a company which has a net profit of 140 odd crores for 2017 is having a market cap more than a company whose net profit is 350 odd crores for 2017… And cash flow is a different story altogether) …only reason i find ( astral sales cagr 5 yrs 26%)…so much talks about efficient market hypothesis😂… If finolex can manage decent growth, then this is going to be a different story altogether…

What was the reason for the dismal margins in Q2? OPM of 10.43% is a big drop from a year ago period where it was 19.04%. Astral seems to have improved its margins in the same period. The split-up of expenses shows a drastic increase in Employee cost for FIL. Why is this so?

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Please check my post above…contains info regarding margins drop and factors that could have effected the same. Finolex Industries - Long Term Compounding Story

A lot here depends upon PVC/EDC delta. Sudden change in crude price hurts them big time. One of the reasons for dismal q2 was plant closure.

Another thing that impacts them is that they manufacture PVC, which is not the case with Astral or others in the same segment. PVC prices get impacted big time with crude price swings. A lot has been said that Finolex is vertically integrated due to PVC but i do not find this good. PVC drags the overall margins in rising crude scenario.

1 Like

Agreed Hao - Ming… Finolex inds is an excellent Co… The possible reason
Astral is at high valuation is due to its customer base being household
retail vs finolex which caters to farmers… This situation is likely to
change for Finolex in coming yrs as they have also entered the household
segment… Finolex is a long term growth story…
Disc… Have investments in Finolex inds

FINOLEX INDUSTRIES - Q3 FY18 (Stand)
Revenue (9.1%) 722.72 Cr vs 662.43 Cr YoY
PAT (-3.3%) 69.54 Cr vs 71.94 Cr YoY

Q3FY18 Concall Highlights (Source: Capital Market) -

  • PVC Pipes & Fittings volume was at 61514 tonne in Q3FY18 up by 50.2% against 40966 tonne in Q3FY17. For 9MFY18 it was at 180278 tonne up by 24.0% against 145357 tonne for 9MFY17.
  • PVC Pipes and fittings volume in the quarter was strong at 50% YoY growth but realization declined by 20% YoY, as the company focused on growing volume through aggressive discounts to dealers despite higher raw material prices.
  • The company indicated that the discounts would continue in next few quarters which will support high volumes.
  • The company expects robust demand in pipes and fittings segment
  • PVC resin volume was at 71107 tonne in Q3FY18 up by 26.5% against 56226 tonne in Q3FY17 (including inter segment transfer). For 9MFY18 PVC resin volume was up by 17.7% to 186644 tonne.
  • The company is confident of reporting strong growth after E-way bill implementation, which is expected to shift business from unorganized players to organized ones.
  • The company has maintained capex guidance of Rs 250 crore in FY17-19 which will take its pipes and fittings capacity to 370000 tonne at the beginning of FY20 and would support its revenue growth.

Likely to benefit from -

  • Govt’s focus on the agriculture and housing sectors
  • Unorganized to orgnaized value migaration
  • Leader in agri pipes currently; envisages to increase the share of non-agri demand in its revenue pie (from 30% currently to ~50% over 4 to 5 years)
  • A ramp-up of higher-margin CPVC volumes over the near term

Geared up for decent YoY growth in coming 2-4 quarters? Traditionally, FY Q4 and Q1 are co’s strong quarters. Q3FY19 will have low base effect benefit (plants shut down for 21 days in Q3FY18 which happen once in three years).

3 Likes