Bloomberg Code: FNXP IN

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1 Feb 3, 215 Consumer Goods - Non Durable Finolex Industries Feb 3, 215 Ltd India Research Stock Broking Bloomberg Code: FNXP IN Shift in business & backward integration to accelerate growth (FIL) could clock a turnover of USD 1billion in the next five years representing a CAGR of 15% to 2% amid transition from B2B business of PVC resin to B2C business of PVC pipes and fittings. We expect the company to deliver Revenue CAGR of 13.2% over FY14-17E. Capacity expansion and increase in distributorship to drive growth: FIL is planning to expand its capacity of the PVC pipes and fittings by approx 4% to 3.2 lakh tones. FIL enjoys strong brand equity in PVC pipe business with strong distribution network and continuous focus on increasing reach across various states specially in the eastern and north-east India. Limited exposure to volatility of raw material prices in PVC pipes and fitting business: FIL established itself as market leader in pipes and fittings segment with its strong backward integration business model which gives unique advantage of operational consistency with quality raw material at lower cost. GOI s focus on agriculture and sanitation segment augurs well for the company: We expect robust demand from the irrigation and sanitation space in the coming years. The 12th five year plan envisages Rs.7.6 lakh crore on agriculture and sanitation segment which is 56% more than that of 11th five year plan. FIL is well placed to tap into the pipes and fittings space. Further increase in PVC/EDC spread to boost margins: A huge capacity of Ethylene is expected to be added to the US market and 2.8 million MTs of new Ethylene Di Chloride (EDC) capacity will come up globally which could bring down raw material costs. Ethylene and EDC used to manufacture PVC resin. Valuation and Outlook FIL is set to witness strong earnings and growth driven by increased production capacity, multi product portfolio, increase in PVC/EDC spread which could reduce the cost of raw material & increase geographic foot prints. Its strong operating cash flow coupled with healthy and sustainable return ratios makes it a value Buy at current level. At CMP Rs. 29, the stock is trading at 9.8x FY17E EPS. We recommend a BUY for a price target of Rs. 359 with an upside of 24%, representing 12x FY17E EPS in a time horizon of 9-12 months. Exhibit 1: Valuation Summary (Rs. Mn) YE Mar FY13 FY14 FY15E FY16E FY17E Net Sales EBITDA EBITDA Margin (%) Adj. Net Profit EPS (Rs.) RoCE (%) PE (x) *5.1 * *For FY13,FY14 PE multiples are on historic basis Recommendation (Rs.) BUY CMP 29 Target Price 359 Upside (%) 24 Stock Information Mkt Cap (Rs.mn/US$ mn) 36 / wk High/Low (Rs.) 347 / 148 3M Avg. daily volume (mn).1 Beta (x).8 Sensex/Nifty 29 / 8756 O/S Shares(mn) Shareholding Pattern (%) Promoters FIIs 4.76 DIIs 4.58 Others Stock Performance (%) 1M 3M 6M 12M Absolute Relative to Sensex Performance Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 FNXP Sensex Source: Bloomberg Technical View The stock has moved up significantly in the past 3-years and has gained multifold from 4 odd levels to an all time high of made during November, 214. Thereafter a healthy dip was witnessed in the counter which dragged it towards the support levels of Currently the stock is trading at 127% Extension levels drawn from the low of 25 levels made during 29 which shall act as immediate support and the next resistance can be pegged at 34 levels. Analyst Contact Joyjit Sinha joyjit.sinha@karvy.com For private circulation only. For important information about Karvy s rating system and other disclosures refer to the end of this material. Karvy Stock Broking is also available on Bloomberg, KRVY<GO>, Thomson Publishers & Reuters 1

2 Feb 3, 215 Company Financial Snapshot (Y/E Mar) Profit & Loss (Rs.mn) FY15E FY16E FY17E Net sales Optg. Exp (Adj for OI) EBITDA Depreciation Interest PBT (excl EI) Tax PAT (excl EI) Profit & Loss Ratios EBITDA margin (%) Net margin (%) P/E (x) EV/EBIDTA (x) Dividend yield (%) Company Background Incorporated in 1981, Finolex industries is the largest manufacturer of rigid PVC Pipes and Fittings and also one of the biggest manufacturer of PVC resins. Its has three manufacturing plants at Pune, Ratnagiri, and Masar. The company s total production capacity for PVC pipes & Fittings business stands at 2,3, MT and that of PVC Resin at 2,72, MT. It has a 43 MW power plant which cater to its captive power requirements. Around 6% of the total power produced is used as captive consumption in the production process. Major raw materials used in the production of PVC Resins are being imported and company has two captive jetties which is used for the procurement of raw materials and another is used for importing coal for the power plant. Balance sheet (Rs.mn) FY15E FY16E FY17E Total Assets Net Fixed assets Current assets Other assets Total Liabilities Networth Debt Current Liabilities Deferred Tax Balance Sheet Ratios RoE (%) ROCE (%) Net Debt/Equity Equity/Total Assets P/BV (x) Cash Flow (Rs.mn) FY15E FY16E FY17E PBT Other Income Interest Tax Changes in WC CF from Operations Capex Investment CF from Investing Change in Equity Debt Dividends CF from Financing Change in Cash Exhibit 2: Shareholding Pattern (%) Exhibit 3: Revenue Segmentation FIIs 5% DIIs 5% Others 38% Promoters 52% Household 3% Agriculture 7% 2

3 Feb 3, 215 Focus on Pipes & Fittings business to give earnings stability FIL has transformed its business model from production and sale of PVC Resin (B2B) to manufacture of PVC pipes & fittings (B2C) by using in-house PVC Resin which could give the earnings stability. PVC pipes and fittings are primarily sold in two market segments i.e agriculture and construction. An increase in disposable income in rural India and GOI s increased importance on irrigation and sanitation will drive the demand for pipes and fittings. Since 1981, FIL established a strong brand in PVC pipes. Increase in volume of fittings in the pipes and fittings basket and sale of value added products like column pipes is already underway. It sells products pan India entirely against advance payments. Currently, the total production capacity of PVC Resin stands at 2,72, MT per annum. GOI s increased thrust on irrigation and sanitation to drive the demand for pipes and fittings. Going forward, FIL expected to benefit from the scaling up of production in PVC Pipes and Fittings segment to 3,2, MT per annum by FY17E. Increase in PVC Pipes & Fittings Volume, Increase in distributorship to drive growth FIL has modified its business model with more focus on Pipes & Fittings business. The Company has registered a CAGR growth of ~15% over FY6 14. We believe the volume growth to drive with the revenue growth and a CAGR growth of 16% can be expected over FY6-17E period. The Company has also registered the highest growth in Q1FY15 at 58,239 MT. With an increase in the total production capacity, we believe that there will be significant increase in the volume of sales amid FIL s new venture into the business of water management and plans to create the solutions to prevent water leakage. FIL enjoys strong brand equity in PVC pipe business with strong distribution network and continuous focus on more penetration in the eastern and in the northen India markets. As a move towards this, a warehouse has already been set up in Cuttack and appointment of new dealers is in process. Exhibit 4: Revenue from pipes and fittings (Rs in Mn) Exhibit 5: Production capacity (in lakh MT) % 64.2% 63.7% % 74.% % Revenue from PVC Pipes & Fittings % contribution to total revenue 1% 75% 5% 25% % Pipes & Fittings (MT in lakh) PVC Resin (MT in lakh) Exhibit 6: Revenue Mix (%) Exhibit 7: Segment EBIT Contribution (%) 1% 75% 5% 25% % 2% 2% 1% 1% 1% 1% 52% 64% 64% 69% 74% 79% 46% 33% 36% 3% 25% 2% PVC Resin PVC Pipes & Fittings Power 7% 35% % PVC Resin PVC Pipes & Fittings Power 61% 66% 55% 6% 67% 7% 3% 9% 2% 14% 36% 9% 32% 8% 27% 6% 26% 4% 3

4 Feb 3, 215 Government Spending on Irrigation and water supply Around 7% of the total revenue of FIL comes from agriculture space. According to NCAER, a substantial amount of Rs. 45, Cr has been allotted to the rural market towards agri inputs. The 12th five year plan envisages Rs.7.6 lakh crore on agriculture and sanitation segment which is 56% more than that of 11th five year plan. As per NCAER, only 43% of the total agricultural land is open to irrigation facility and with the government focus on irrigation and water supply, there will be an increase in demand for the PVC Pipes & Fittings. Finolex, being the largest player in manufacturing of PVC Pipes & Fittings, which forms an important part of agri inputs and holds 28% in the organized market sector is likely to benefit and could be well placed to tap the opportunity in Pipes and Fittings space. Fully Backward Integrated PVC pipes & fittings is now the major contributor to the revenue of the company and requires PVC Resins for the production which the company manufacture on its own. FIL is currently one of the largest producers of PVC Resin in India with a production capacity of 2,72, MT. PVC Resin further requires EDC, Ethylene, VCM for manufacturing of PVC Resins and are being imported with the help of their own jetty which reduces their freight cost. FIL has even set up a power plant with a capacity of 43 MW for captive consumption. Adding to the above, it also owns 2 water reservoirs and a jetty (for importing coal for power plant). Enhancement of the production capacity is also being done with minimum capex as the company already has ample land for the expansion. Shift in preference from GI pipes to PVC pipes As of now, only 43% of the total agricultural land is open to irrigation facility and has been dominated by GI pipes. PVC pipes are advantageous over GI pipes as they are cheaper, corrosion free, light weight (easy to transport) easy to install and have a greater life span as compared to GI pipes. As a result, there has been a strong shift in the consumer preference for the use of PVC pipes over GI pipes. We expect the trend to continue over the coming years providing ample opportunity for growth. Exhibit 8: Business Assumptions Y/E Mar (Rs. Mn) FY14 FY15E FY16E FY17E Comments India Business (Standalone) Revenue We expect the revenue for pipes & fittings to grow at 14.4% CAGR over FY14-17E. Revenue Growth (%) We expect growth mainly due to capacity expansion in the PVC Pipes & Fittings business which is likely to lead to robust volume growth. EBITDA Substantial revenue growth due to volume growth in PVC Pipes business and cost control to result in higher EBITDA. EBITDA Margins (%) Shift in business focus from Resin to Pipes & Fittings to expand EBITDA Margins. PAT (normalized) Higher volume growth coupled with lower finance cost to generate higher PAT. EPS Net CFO Net Debt Lower capex leading to healthy cash flows to help reduce debt. 4

5 Feb 3, 215 Revenue Pipes & Fitting segment gaining momentum Exhibit 9: Revenue & Growth % 16% 14% 12% 15% 1% 6% 5% 5% 2% % Revenue (Rs. Mn) Growth Finolex industries has registered a steady growth of 7.4% CAGR over FY11-14 driven by pipes and fitting segment with a CAGR growth of 19.6%. We expect the momentum for pipe and fitting business to remain in positive traction and register a CAGR growth of 19.2% over FY14-17E, while the overall revenue is expected to grow at 1.8% CAGR over FY14-17E. Further increase in PVC/EDC spread to boost margins Exhibit 1: EBITDA & EBITDA Margins (%) % 18% 19% 17% 16% 1% % 14% 8% 2% EBITDA (Rs. Mn) EBITDA Margin It is expected that a huge capacity of Ethylene to be added to the US market and 2.8 million MTs of new Ethylene Di Chloride (EDC) capacity will come up globally which could bring down raw material costs and thus EBITDA and EBITDA margins might get a booster. Ethylene and EDC are used to manufacture PVC resin. Segmental growth to improve PAT consistently Exhibit 11: PAT and PAT Margins (%) 4 15% 1.8% 1.1% 11.% 3 9.8% 9.4% 1% 2 3.6% 5% PAT (Rs. Mn) PAT Margin % FIL has shown consistent improvement in PAT on the back of growth in pipe and fittings business. We expect FIL to deliver a PAT margin of above 9 % in the next three years. We expect limited capex during FY15E to FY17E period and the finance cost to remain constant. Consistent improvement in PAT and ROCE Exhibit 12: PAT Vs ROCE % % 31.7% 23.1% 24.3% 21.3% PAT (Rs. Mn) ROCE 4% 3% 2% 1% % PAT has shown continuous growth historically with strong revenue growth and high sales realization per MT basis of PVC pipes. We expect FIL s growth momentum to carry on the back of strong demand for PVC pipes in the rural India, increasing contribution from fitting and column pipes business. On the same line, FIL witnessed expansion of ROCE and we expect ROCE will improve further in the next three years. 5

6 Feb 3, 215 Cash balance to improve, Limited Capex, Cash EPS to improve Exhibit 13: Free Cash Flow, Operating Cash Flow and Cash EPS, Operating and Free Cash Flow (Rs.in Mn) Operating Cash Flow Free Cash Flow Cash EPS Healthy Debt-Equity and Current Ratio/ Set to have better Interest Coverage and Operating Cash Flow Ratios Exhibit 14: Key Ratios (in x) Increase in PAT combined with expected low capex will result in strong 1 operating cash flow, thus resulting in the growth of cash EPS OCFR Current Ratio Interest Coverage Debt Equity Ratio Current ratio has been more than 2 times over the past 9 years, shows an overall good working capital management. We expect debt-equity ratio to become healthier, with better interest coverage ratio. Current liabilities are well covered by operating cash flow. Good proxy for dividend in terms of dividend yield Exhibit 15: Dividend per share (Rs) / Dividend Payout and Yield Exhibit 16: Company Snapshot (Ratings) FIL s dividend payout ratio is consistent during the period FY9-FY14 with decent payout ratios. We believe that the company will maintain stable dividend payout in the next couple of years. Low High Quality of Earnings 99 Domestic Sales 99 Exports 99 Net Debt/Equity 99 Working Capital req 99 Quality of Management 99 Depth of Management 99 Promoter 99 Corporate Governance Dividend per Share Dividend Yield % Dividend Payout % 6

7 Feb 3, 215 Valuation Absolute Valuation Finolex Industries Limited is trading below the average P/E of its peers which is justified as FIL is focused towards production of Resin and manufacturing of PVC pipes and fittings, whereas others are diversified into manufacturing of other plastics and chemicals with PVC pipes & fittings only forming a part of their total revenue. Peer Comparison Finolex operates in the manufacturing of Resin and PVC Pipes & Fittings, whereas its competitors are diversified into manufacturing of various plastics products, Chemical and PVC pipes & Fittings only forming a portion of its total revenue. Exhibit 17: Comparative valuation summary CMP M-cap EV/EBITDA (x) P/E (x) RoE (%) (Rs. mn) FY15E FY16E FY17E FY15E FY16E FY17E FY15E FY16E FY17E Supreme Ind Jain Astral FIL Source: Company, Bloomberg, Karvy Research Exhibit 18: Revenue CAGR over (FY8-14) (%) 4% Exhibit 19: EBITDA Margins (%) % 15 %.9% 8.7% 7.9% 6.9% 8.% FY1 FY11 FY12 FY13 FY14 Supreme Jain Astra Finolex FY1 FY11 FY12 FY13 FY14 Supreme Jain Astra Finolex Exhibit 2: EPS (in Rs.) 25 Exhibit 21: RoCE (%) FY1 FY11 FY12 FY13 FY14 1 FY1 FY11 FY12 FY13 FY14 Supreme Jain Astra Finolex Supreme Jain Astra Finolex 7

8 Feb 3, 215 At current price of Rs. 29 per share, Finolex trades at a P/E of 14.8x, 12x and 9.7x of FY15E, FY16E and FY17E EPS respectively. We have used the sum of the parts (SOTP) method to value FIL. We have assigned a P/E multiple of 9x to its core PVC Pipes & Fittings business, we have valued FIL s stake in Finolex Cables at a 5% discount to market price and land valuation arriving at per share value of Rs With this, we arrive at a combined target price of Rs. 359 per share; with an upside of 24% from the CMP. Exhibit 22: Finolex Industries SOTP Valuation EV/EBIDTA (x) P/E (x) RoE (%) EPS (FY17E) 29.7 CMP of Finolex Cables Chinchiwad 7 Average P/E 9 No of Shares of Finolex cables Price Per Acre (Rs. in Mn 11 Per Share Value 268 Total Value of Finolex cables Total value (Million) 77 Finolex Industries Share 15% Ratnagiri 6 Current Value of Investment 582 Price Per Acre (Rs. in Mn) 1.1 Holding company discount Total value (Rs. in Mn) 66 Per share value 23.4 Total Land Cost (Rs. in Mn) 836 Per Share Value Exhibit 23: Price Earning Ratio (PE) Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Historically, FIL was trading within the average P/E multiple of 9 and 14.2 on 1 year forward PE multiple of (FY15E EPS). We have assigned a P/E multiple of 12x based on FY17E EPS of Rs.29.7 per share on expectations of increased production capacity, multi product portfolio, increase in PVC/EDC spread as well as expand its foot print. Key Risks Subdued demand in agriculture and construction sector Sharp increase in raw material prices Poor monsoon Currency fluctuations 8

9 Feb 3, 215 Financials Exhibit 24: Income Statement YE Mar (Rs. Million) FY13 FY14 FY15E FY16E FY17E Revenue Growth (%) Operating Expenses EBITDA Growth (%) Depreciation & Amortization Other Income EBIT Interest Expenses PBT Tax Adjusted PAT Growth (%) Exhibit 25: Balance Sheet YE Mar (Rs. Million) FY13 FY14 FY15E FY16E FY17E Cash Sundry Debtors Inventory Loans & Advances Investments Gross Block Net Block CWIP Miscellaneous Total Assets Current Liabilities & Provisions Debt Other Liabilities 936 1,63 1,63 1,63 1,63 Total Liabilities Shareholders Equity Reserves & Surplus Total Networth Minority Interest Total Networth & Liabilities

10 Feb 3, 215 Exhibit 26: Cash Flow Statement YE Mar (Rs. Million) FY13 FY14 FY15E FY16E FY17E PBT Depreciation Interest Tax Paid Inc/dec in Net WC Other Income Other non cash items Cash flow from operating activities Inc/dec in capital expenditure Inc/dec in investments Others Cash flow from investing activities Inc/dec in borrowings Issuance of equity Dividend paid Interest paid Others Cash flow from financing activities Net change in cash Exhibit 27: Key Ratios YE Mar (%) FY13 FY14 FY15E FY16E FY17E EBITDA Margin (%) EBIT Margin (%) Net Profit Margin (%) Dividend Payout ratio (%) Net Debt/Equity RoE (%) RoCE (%) Exhibit 28: Valuation Parameters YE Mar FY13 FY14 FY15E FY16E FY17E EPS (Rs.) DPS (Rs.) BV (Rs.) PE (x) *5.1 * P/BV (x) *1.7 * EV/EBITDA (x) *5.3 * EV/Sales (x) *.9 * *The valuation multiples are based on historic numbers 1

11 Feb 3, 215 Stock Ratings Absolute Returns Buy : > 15% Hold : 5-15% Sell : <5% Connect & Discuss More at For further enquiries please contact: research@karvy.com Toll Free: Analyst certification Disclosures Appendix The following analyst(s), who is (are) primarily responsible for this report, certify (ies) that the views expressed herein accurately reflect his (their) personal view(s) about the subject security (ies) and issuer(s) and that no part of his (their) compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report. Disclaimer The information and views presented in this report are prepared by Karvy Stock Broking Limited. The information contained herein is based on our analysis and upon sources that we consider reliable. We, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and we are not responsible for any loss incurred based upon it. The investments discussed or recommended in this report may not be suitable for all investors. Investors must make their own investment decisions based on their specific investment objectives and financial position and using such independent advice, as they believe necessary. While acting upon any information or analysis mentioned in this report, investors may please note that neither Karvy nor Karvy Stock Broking nor any person connected with any associate companies of Karvy accepts any liability arising from the use of this information and views mentioned in this document. The author, directors and other employees of Karvy and its affiliates may hold long or short positions in the above mentioned companies from time to time. Every employee of Karvy and its associate companies are required to disclose their individual stock holdings and details of trades, if any, that they undertake. The team rendering corporate analysis and investment recommendations are restricted in purchasing/selling of shares or other securities till such a time this recommendation has either been displayed or has been forwarded to clients of Karvy. All employees are further restricted to place orders only through Karvy Stock Broking Ltd. This report is intended for a restricted audience and we are not soliciting any action based on it. Neither the information nor any opinion expressed herein constitutes an offer or an invitation to make an offer, to buy or sell any securities, or any options, futures nor other derivatives related to such securities. Karvy Stock Broking Limited Karvy Centre, Avenue-4, 2nd Floor, Road No: 1, Banjara Hills, Hyderabad India. Tel: ; Fax: For More updates & Stock Research, visit 11