INITIATING COVERAGE 08 MAY 2017 Finolex Industries · INITIATING COVERAGE 08 MAY 2017 Finolex Industries BUY . On a CPVC high . Finolex Industries (Finolex) is a key branded player

INITIATING COVERAGE 08 MAY 2017

Finolex Industries BUY

On a CPVC high Finolex Industries (Finolex) is a key branded player in the organised PVC pipes market in India, enjoying a volume market share of ~19%. Its pipes and fittings capacity is 280k TPA, in a growing national market of 1,800k TPA. Only 60% of this market is organised.

Finolex has a key edge owing to its backward integration (into PVC resin). This is significant as PVC demand in India outpaces supply by ~50%, leaving pipe extruders at the mercy of commodity prices. While resin making is also subject to similar vagaries, we believe integration reduces overall margin volatility. PVC resin capacity is ~272k TPA. Some 55-60% of the resin is captively consumed, a ratio that could increase to 65-70% by FY19E.

Finolex has forayed into CPVC pipes, under the ‘Finolex FlowGuard Plus’ brand, post its tie up with Lubrizol in Feb 2017. This is a fast growing, lucrative and premium segment of the market, and offers more scope for better brand building than the PVC segment, where Finolex is already a key player.

With high return ratios, a strong brand driving into structural demand tailwinds, backward integration, the CPVC foray, sustained demand and GST tailwinds, Finolex offers several years of compounding potential. Initiate with a BUY and a 1-year fwd TP of Rs 760 (25x Mar-19E EPS).

Key investment arguments Enormous opportunity: India’s PVC market is grossly

under-penetrated, with a per capita consumption at ~2 kg. This is ~3-4x higher in countries such as Brazil, Malaysia, Thailand. With rapid urbanization and rising farm irrigation spends, the market can grow at 12-15% CAGR to ~Rs 350bn over the next 3 years. Finolex is the largest organized PVC pipe brand, and benefits from GST rollout as unorganized players feel the heat. Its distribution network comprises ~700 dealers and ~17,000 retail touch points across India.

CPVC to drive next leg of growth: Finolex plans to ramp-up its CPVC volumes exponentially over the near term, from ~4,000 to ~20,000 MTPA. CPVC EBIT margins are higher at 10%+, which should support overall margins.

RM spreads pose risk: Finolex imports ethylene, EDC and VCM, which are required to manufacture PVC resin. While the PVC/EDC spread was favourable in 9MFY17 (translating into superior margins), it remains a key monitorable, going ahead.

Financial Summary (Rs mn) FY16 FY17E FY18E FY19E Net Sales 24,528 25,094 28,594 33,039 EBITDA 3,751 5,214 4,941 5,761 APAT 2,336 3,239 3,156 3,778 Diluted EPS (Rs) 18.8 26.1 25.4 30.4 P/E (x) 30.8 22.2 22.8 19.1 EV / EBITDA (x) 19.7 14.0 14.6 12.4 RoE (%) 26.8 31.0 26.3 27.8 Source: Company, HDFC sec Inst Research

INDUSTRY PIPES

CMP (as on 8 May 2017) Rs 563

Target Price Rs 760

Nifty 9,314

Sensex 29,926

KEY STOCK DATA

Bloomberg FNXP IN

No. of Shares (mn) 124

MCap (Rs bn) / ($ mn) 70/1,091

6m avg traded value (Rs mn) 39

STOCK PERFORMANCE (%)

52 Week high / low Rs 600/359

3M 6M 12M

Absolute (%) 15.9 27.2 54.8

Relative (%) 10.1 18.7 36.2

SHAREHOLDING PATTERN (%)

Promoters 52.5

FIs & Local MFs 8.9

FPIs 4.0

Public & Others 34.6

Source : BSE

Sonali Salgaonkar [email protected] +91-22-6171-7322

HDFC securities Institutional Research is also available on Bloomberg HSLB <GO>& Thomson Reuters

FINOLEX INDUSTRIES : INITIATING COVERAGE

PVC: Enormous opportunity in India The global PVC market is expected to grow at a

steady CAGR of ~4%, from USD ~55-60 bn currently to ~USD 65-70 bn over the next five years. Globally, PVC is the third largest plastic, in terms of both production and consumption.

Global PVC consumption stood at 40-45mn tonnes in 2014. Demand for PVC in the Indian sub-continent (~7% of global PVC demand) notably outpaced supply (~3% of global supply) during this period.

Currently, the per capita consumption of PVC in India is abysmal, at ~2kg per person. It is ~3-4x in other peer developing countries, and ~6x in developed countries.

Per Capita PVC Consumption , Across Countries

Source: Company AR, industry, HDFC sec Inst Research

Global PVC Demand Break-Up (2014) Global PVC Capacity Break Up (2014)

Source: Company AR, Industry, HDFC sec Inst Research Source: Company AR, Industry, HDFC sec Inst Research

The Indian subcontinent accounts for ~7% of the global PVC demand …and 3% of global PVC capacities. Thus, PVC demand outpaces supply in the Indian subcontinent The per capita consumption of PVC in India is abysmal, at ~2 kg per person. The per capita consumption of PVC in peer developing countries is 3-4x higher, whereas it is almost 6x higher in developed countries.

2

5.6

7.68.8

10.3

12.7

0

2

4

6

8

10

12

14

India Brazil Malaysia Thailand China USA

kg/person

NE Asia48%North

America14%

Western Europe

10%

SE Asia5%

Central Europe

2%

South America

5%

Indian subcontinent

7%

Middle East6%

Africa3%

NE Asia55%

Indian subcontinent

3%

N America16%

West Europe

12%

SE Asia4%

Central Europe

4%

S America3%

Middle East2% Africa

1%

Page | 2


Multiple demand drivers

The Indian pipes industry stands at around Rs 220-230 bn, with the irrigation and construction sectors largely driving demand. As per industry sources, the Indian pipes market is expected to grow at a 12-15% CAGR to touch ~Rs 350 bn in the next 3 years.

The Indian PVC industry is characterised by < 10 large manufacturers and more than 6000 processors. Finolex is one of the largest PVC resin producers in India, with a resin capacity of ~272k MT.

Supreme Industries is one of the main players in the organised PVC pipes market, with plastic piping volumes at ~235k MT and piping capacity at ~400K MT. The company operates at 15-16% EBITDA margin in the piping segment, with a relatively higher proportion of fittings in it. Finolex is gradually increasing the proportion of the higher-margin fittings in the company’s pipes segment.

Usage Of PVC In India

Source: Company AR, industry, HDFC sec Inst Research

Notable opportunities for the pipes segment in India:

Almost 70% of the demand for PVC pipes and fittings stems from the agriculture sector (including irrigation and water supply). The remaining 30% is accounted for by the building sector (plumbing, sewage pipes and drainage).We believe that there exist enormous opportunities for pipe manufacturers, given the government’s thrust on agriculture as well as the impetus provided to the housing.

Impetus to the agriculture sector: In 2017-18, the overall allocation for the rural and the agriculture sector stands at around ~Rs 1872bn. Increased allocation (of ~ Rs400bn) for investment in the irrigation sector could fuel growth in the pipes and fittings segment in the coming years. Further, a dedicated micro-irrigation project (worth ~Rs 50bn) is likely to be set up by NABARD. Also, as a measure to increase the level of financial liquidity available to farmers, the target for agri-credit is fixed at around Rs 10,000 bn.

Impetus to the non-agriculture sector: In FY18E, affordable housing is proposed to be given infrastructure status. Also, nearly 10 mn houses are proposed to be built by 2019. Moreover, the Government’s initiative of the ‘Swachh Bharat Mission’ (Gramin) is bearing fruit, with sanitation coverage in rural India increasing to ~60% currently from ~42% in October 2014. Lack of sanitation and inadequate supply of drinking water in many regions provide notable growth opportunities for the piping industry.

The Indian pipes market stands at ~Rs 220-220bn and is expected to grow at ~12-15% CAGR over the next few years, to around Rs 350 bn by FY19E. Pipes and fittings account for almost three-fourth of the PVC demand in India Immense government thrust on the agriculture sector, with multiple schemes announced in the Union Budget 2017-18 Increased focus on affordable housing as well as sanitation (Swachh Bharat Mission) are expected to boost demand for pipes

Pipes & Fittings

73%

Films & Sheets

5%

Wires & Cables

1%

Others21%

Page | 3


Finolex: Integrated player In India, the addressable market for PVC pipes stands

at ~1,800k MT, of which ~60% (1,080k MT) is accounted for by the organised sector and the remaining, by the unorganised.

In the organised pipe market, Finolex is one of the key branded companies, enjoying ~19% volume market share. The cumulative pipes and fittings capacity of Finolex stands at ~280k MT.

Also, Finolex is backward integrated, and is one of the largest PVC resin producers in India, with a capacity of 272k MT. Around 55-60% of the PVC resin manufactured by the company is utilised for captive consumption, and the remainder is sold externally.

We believe that the proportion of captive consumption of resin could increase in the coming years, gradually transforming the company’s business model to B-to-C.

In India, consumption of PVC stands at ~3mn tonnes, whereas production is ~1.5mn tonnes. Most pipe manufacturers import ~50% of their raw materials (mainly PVC resin). We believe that backward integration into production of PVC resin gives Finolex an edge, as it reduces dependence on imported resin.

Finolex’s capacities are located at Ratnagiri, Pune and Goa. Also, the company has a 43MW power plant in Ratnagiri, mainly used for captive consumption.

Finolex Industries: Segmental Snapshot

Source: Company, HDFC sec Inst Research

In India, the PVC pipe demand stands at ~1.8 mn tonnes, of which ~60% is the organised market and 40% is unorganised. Finolex is one of the key players, enjoying volume market share of ~19%. Its pipe capacity stands at ~280k MT. Finolex pursues backward integration in the production of PVC resin, with a capacity of ~272k MT at Ratnagiri Almost 55-60% of the PVC resin manufactured is utilised captively for its own pipe production, the rest is sold externally

Finolex Industries9MFY17 snapshot:Revenue: Rs 19,627mn (4% YoY)EBIT margin: ~17% (12% YoY)

PVC pipes and FittingsVolume: 145,357 MT (3% YoY) Revenue: Rs 15,127mn (10% YoY)EBIT: Rs 1,123 mn (3% YoY)EBIT margin: 7.2% (7.8% YoY)

PVC Resin (captive+ external)Volume: 159,103 MT (-4% YoY) Revenue: Rs 11,474mn (3% YoY)EBIT: Rs 2,375 mn (76% YoY)EBIT margin: 20.6% (11.5% YoY)

Power9MFY17 snapshot:Revenue: Rs 1,087mn (4% YoY)EBIT: Rs 273 mn (48% YoY)EBIT margin: 24.7% (17.4% YoY)

Pipes134,125 MT ( 3% YoY)

Fittings11, 232 MT ( 9% YoY)

Internal (captive)107,451 MT (8%

YoY)

External51,652 MT (-21% YoY)

Page | 4


Products encompassing segments Finolex offers a wide range of PVC pipes and fittings

for diverse applications, including Agricultural pipes, Column pipes, Casing pipes, ASTM pipes and fittings, Sewerage pipes and CPVC pipes. Agriculture (including irrigation and water supply) accounts for ~70% of the demand for PVC pipes.

Finolex’s cumulative pipes and fittings capacity stands at 280k MT. Over the next three years, the company plans to increase this capacity by 100k MT (mainly brownfield), entailing an estimated capex of Rs 1.5bn. Also, going ahead, we estimate notable volume growth in the higher-margin fittings segment, thereby supporting margins.

Finolex Industries: Product Solutions For Various Segments


Agriculture accounts for ~70% of the demand of the pipe industry and comprises mainly of irrigation and water-supply Building accounts for ~30% of the demand for pipes, and comprises mainly of plumbing, sewage pipes and drainage Finolex offers a wide range of pipes, catering to multiple segments Over the next 3 years, Finolex plans to increase its pipes and fittings capacity by 100k MT (mainly brown field), entailing an estimated capex of Rs 1.5 bn.

Organized PVC Pipes industry~1,800,000 MT

Irrigation Water supply

Building (30%)

Plumbing Sewage Pipes Drainage

Agriculture (70%)

Agricultural pipes and fittings

Column Pipes

Casing Pipes

ASTM Pipes and fittings

Sewerage pipes

CPVC Pipes and fittings

Page | 5


Riding the CPVC bandwagon The Indian CPVC (Chlorinated PVC) market is at a

relatively nascent stage, with annual volumes at 100- 110k MT. Currently, key players in this segment are Ashirwad Pipes, Astral Polytechnik and Supreme Industries.

CPVC is largely considered a premium product (compared to PVC), and is typically priced at a 25-30% premium to normal PVC pipes, with segmental EBIT margins higher than 10%.

In February 2017, Finolex and Lubrizol Corporation entered into an agreement for the manufacture and sale of ‘Finolex FlowGuard’ Plus CPVC pipes and fittings in India. This product is expected to be launched in Q1FY18, and would cater to the housing and real estate segments.

CPVC is typically used in piping applications warranting temperature fluctuations, such as transportation of hot and cold water, especially in the building segment.

Lubrizol’s CPVC technology can be found in three main products, namely (1) ‘FlowGuard’ - pipes and fittings, (2) ‘Blaze Master’ - fire sprinkler system and (3) ‘Corzan’ - industrial systems. Of these, ‘Flow Guard’ CPVC pipes are largely used in plumbing applications and constitute a lion’s share of the overall CPVC market.

As per industry sources, the market for Indian CPVC pipes is expected to gradually outpace the growth rate of the Indian PVC pipes market. Key demand drivers are expected to be government initiatives to promote housing, coupled with lower interest rates.

Further, the introduction of GST (Goods and Services Tax) could trigger a gradual shift from the unorganised to the organised market, benefitting organised players (such as Finolex).

CPVC Market - Player - Wise Volume Market Share

Source: Company, Industry, HDFC sec Inst Research

Finolex to scale up CPVC business

Finolex envisages scaling up its CPVC volumes to almost 20k MT, from ~4k MT in the coming years.

Over FY16-19E, we expect Finolex’s CPVC volumes to grow four to five times.

Although CPVC is estimated to constitute less than 10% of Finolex’s overall pipe volumes, the segmental margin is expected to remain firm, owing to its premium pricing.

The Indian CPVC pipe demand is estimated at ~100-110k MT. CPVC is regarded as a premium product as compared to PVC, and is priced at a premium of 25-30%. Key players in CPVC are Astral and Ashirwad, each enjoying around 25-30% market share in this segment. In February 2017, Finolex and Lubrizol Corporation entered into an agreement for the manufacture and sale of ‘Finolex FlowGuard’ Plus CPVC pipes and fittings in India. Over FY16-19E, we expect Finolex’s CPVC volumes to grow by 3-4x, thus supporting segmental margins of pipes and fittings

Astral25-30%

Ashirwad Pipes

25-30%

Supreme10-15%

Others25-30%

Page | 6


RM spreads favourable, as of now Ethylene Dichloride (EDC) and Vinyl Chloride

Monomer (VCM) are the key raw materials used for the production of PVC resin. This in turn, is the key raw material used for manufacturing pipes and fittings. Finolex largely imports ethylene, EDC and VCM. The company is backward integrated in the production of PVC resin. Over FY11-16, RM cost as a percentage of company’s revenue stood at 65-70%.

Over 9MFY17, the spread of PVC/EDC has improved notably, owing to (1) Firm prices of PVC, following rationalisation in global production and (2) Low EDC prices, owing to higher availability of ethylene. This has led to Finolex’s segmental EBIT margin improving to 20.5% in 9MFY17, compared to 11.5% in 9MFY16.

Going ahead, any volatility in the PVC/EDC spread is a key monitorable for the company, and could potentially affect profitability.

EDC: While EDC is a derivative of crude, it generally follows its own demand-supply equation. Additional EDC capacities are likely to come up in the near term, which are expected to keep prices low.

VCM: VCM is an intermediate in the EDC to PVC chain. Generally, international VCM prices follow international PVC prices quite closely. Typically, international demand and supply of VCM is quite balanced.

Finolex is backward integrated, and largely uses its manufactured PVC resin for production of pipes. The company also imports a small quantity of PVC resin. We believe that backward integration is a key differentiator for Finolex, as it could de-risk the company’s business, to an extent.

Trend In PVC/EDC Delta (In USD/MT) Finolex: Break Up Of Raw Materials (FY16)

Source: Company, Industry, HDFC sec Inst Research Source: Company AR, Industry, HDFC sec Inst Research

EDC and VCM are the key raw materials for PVC resin, which in turn is the key raw material for manufacturing pipes and fittings. Finolex largely imports ethylene, EDC, VCM and is backward integrated into production of PVC resin. Over 9MFY17, the spread of PVC/EDC has improved notably In 9MFY17, Finolex’s segmental EBIT margin improving to 20.5% in 9MFY17, compared to 11.5% in 9MFY16.

EDC14%

Ethylene17%

VCM28%

Coal4%

PVC (excluding

captive)11%

Others25%

300

400

500

600

700

800

900

Dec

-11

Mar

-12

Jun-

12Se

p-12

Dec

-12

Mar

-13

Jun-

13Se

p-13

Dec

-13

Mar

-14

Jun-

14Se

p-14

Dec

-14

Mar

-15

Jun-

15Se

p -15

Dec

-15

Mar

-16

Jun-

16Se

p-16

Dec

-16

PVC/EDC DeltaUSD/MT

Page | 7


Pipes And Fittings – Quarterly Trends Trend In Volumes Of Pipes Trend In Volumes Of Fittings

Source: Company, HDFC sec Inst Research Source: Company, HDFC sec Inst Research

Trend In Revenue Of Pipes & Fittings Quarterly Trend In EBIT Margin Of Pipes & Fittings


Pipes and fittings is a key segment in Finolex, and contribute ~50% to the company’s revenue. Q1 and Q4 cumulatively account for ~60% of the annual volumes and revenues in pipes and fittings. We expect the proportion of the higher-margin fittings to gradually increase in the overall volumes of the company. In 9MFY17, the average EBIT margin for pipes and fittings stood at 7-8%.

37,196 39,163

63,387 62,255

34,21837,652

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Q2F

Y16

Q3F

Y16

Q4F

Y16

Q1F

Y17

Q2F

Y17

Q3F

Y17

Finolex's Pipes Volumes YoY growth (%) - RHS

in MT

3,494 3,282

4,3063,870 4,048

3,314

0%5%10%15%20%25%30%35%40%45%

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

Q2F

Y16

Q3F

Y16

Q4F

Y16

Q1F

Y17

Q2F

Y17

Q3F

Y17

Finolex's Fittings Volumes YoY growth (%) - RHS

in MT

3,978 4,073

6,310 6,581

4,1004,446

0%

5%

10%

15%

20%

25%

30%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Q2F

Y16

Q3F

Y16

Q4F

Y16

Q1F

Y17

Q2F

Y17

Q3F

Y17

Revenue from Pipes & Fittings YoY growth (%) - RHS

Rs mn

0%1%2%3%4%5%6%7%8%9%10%

0

100

200

300

400

500

600

Q2F

Y16

Q3F

Y16

Q4F

Y16

Q1F

Y17

Q2F

Y17

Q3F

Y17

Pipes & Fittings - Segmental EBIT Margin (%) RHS

Rs mn

Page | 8


PVC Resin - Quarterly Trends Trend In Volume Of PVC Resin Trend In Revenue Of PVC


Trend In EBIT Margin Of PVC


Increasingly, a larger proportion of PVC resin is used for captive consumption, for production of pipes and fittings. The average EBIT margin for PVC segment stood at ~21% in 9MFY17, mainly on account of favourable PVC/EDC spread.

2,802

3,884

4,9794,336

2,759

4,379

-30%

-20%

-10%

0%

10%

20%

30%

40%

0

1,000

2,000

3,000

4,000

5,000

6,000

Q2F

Y16

Q3F

Y16

Q4F

Y16

Q1F

Y17

Q2F

Y17

Q3F

Y17

PVC Revenue YoY growth (%) - RHS

Rs mn

41,512

60,542

83,093

62,435

39,902

56,766

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

010,00020,00030,00040,00050,00060,00070,00080,00090,000

Q2F

Y16

Q3F

Y16

Q4F

Y16

Q1F

Y17

Q2F

Y17

Q3F

Y17

Finolex's PVC volume sales YoY growth (%) - RHS

in MT

0%

5%

10%

15%

20%

25%

0100200300400500600700800900

1,000

Q2F

Y16

Q3F

Y16

Q4F

Y16

Q1F

Y17

Q2F

Y17

Q3F

Y17

PVC - Segmental EBIT Margin (%) RHS

Rs mn

Page | 9


Power Segment - Quarterly Trends Trend In Revenue of Power Quarterly Trend In EBIT Margin Of Power


The average EBIT margin for the power segment stood at around ~25% in 9MFY17.

0%

5%

10%

15%

20%

25%

30%

35%

0

20

40

60

80

100

120

140

Q2F

Y16

Q3F

Y16

Q4F

Y16

Q1F

Y17

Q2F

Y17

Q3F

Y17

Power - Segmental profit (EBIT) Margin (%) RHS

Rs mn

299

357 355388

321

378

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

050

100150200250300350400450

Q2F

Y16

Q3F

Y16

Q4F

Y16

Q1F

Y17

Q2F

Y17

Q3F

Y17

Revenue from Power segment YoY growth (%) - RHS

Rs mn

Page | 10


Financials Trend In Revenue And Y-o-Y Growth Segmental Revenue Breakup


Trend In EBITDA And Operating Margin (Core) Trend In Adj. PAT And PAT Margin


The top line is expected to grow at ~10% CAGR over FY16-19E Revenue growth in FY17E is expected to be flattish on account of subdued volumes in H2FY17, owing to demonetisation Margins are estimated to be higher in FY17E, on account of a favourable PVC/EDC trend in 9MFY17E. Adjusted earnings are expected to grow at ~17% CAGR over FY16-19E.

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

FY15

FY16

FY17

E

FY18

E

FY19

E

Net revenue (in Rs bn) y-o-y growth (RHS)

0%

2%

4%

6%

8%

10%

12%

14%

0.0

0.5

1.0

1.5

2.0

2.5

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3.5

4.0

FY15

FY16

FY17

E

FY18

E

FY19

E

Adj. PAT (in Rs Bn) PAT margin (%) - RHS

0%

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25%

0.0

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FY16

FY17

E

FY18

E

FY19

E

EBITDA - Core (in Rs Bn) EBITDA margin (%) - RHS

0%

10%

20%

30%

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50%

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70%

80%

90%

100%

FY12

FY13

FY14

FY15

FY16

FY17

E

FY18

E

FY19

E

PVC Pipes and Fittings Power

Page | 11


Volume Trend Of Pipes And Fittings Volume Trend Of PVC resin


Trend In RoE And RoCE Break-up Of Cost Structure (9MFY17)


The proportion of fittings in overall volumes is expected to gradually increase over the years, thereby supporting margins. Increasingly, a larger proportion of PVC resin is expected to be used for captive consumption. Return ratios are expected to notably improve from the current levels; FY15 was an exceptional year, when the company realised an inventory loss, owing to a sudden dip in crude prices Raw material is the main cost for the company, constituting ~76% of the overall costs in 9MFY17

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

FY15

FY16

FY17

E

FY18

E

FY19

E

RoE (%) RoCE (%)

0

50

100

150

200

250

300

FY15

FY16

FY17

E

FY18

E

FY19

E

Total PVC (000 MTPA) Captive PVC (000 MTPA)

Raw material

cost76%

Employee expenses,

6%

Power & fuel, 4%

Other costs, 14%

0

50

100

150

200

250

300

FY12

FY13

FY14

FY15

FY16

FY17

E

FY18

E

FY19

E

Pipes (000 MTPA) Fittings (000 MTPA)

Page | 12


Trend In Working Capital Cycle Trend In Net Gearing


Quarterly Trend In Segmental RoCE


61

51 51 50 50

0

10

20

30

40

50

60

70

FY15

FY16

FY17

E

FY18

E

FY19

E

Working capitalDays0.8

0.2

0.1

0.0

0.0-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

FY15

FY16

FY17

E

FY18

E

FY19

E

Net Debt-equity ratio

The working capital cycle is expected to remain at current levels. The company demonstrates negligible receivables on account of its ‘Cash and Carry’ model Finolex is expected to virtually become debt-free by FY19E

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Q2F

Y16

Q3F

Y16

Q4F

Y16

Q1F

Y17

Q2F

Y17

Q3F

Y17

PVC Pipes and Fittings Power

%

Page | 13


Company background Finolex was incorporated in 1981, as a PVC pipe

manufacturing company. In 1994, the company backward integrated into the manufacture of PVC resin, setting up a plant for the same at Ratnagiri.

Currently, Finolex’s three main business segments are (1) Pipes and fittings (contributing ~52% to revenues in FY16), (2) PVC resin (contributing ~44% to revenues in FY16, including captive consumption) (3) Power (~4% of FY16 revenues, including captive consumption).

Finolex has recently forayed into the CPVC pipes business. In February 2017, Finolex and Lubrizol Corporation entered into an agreement for the manufacture and sale of ‘Finolex FlowGuard’ Plus CPVC pipes and fittings in India. This product is

expected to be launched in Q1FY18 and would cater to the housing and real estate sectors.

Ethylene Dichloride (EDC) and Vinyl Chloride Monomer (VCM) are the key raw materials for production of PVC resin. This, in turn, is the main raw material for the manufacture of pipes and fittings. Finolex largely imports ethylene, EDC and VCM, and is backward integrated into the production of PVC resin.

Currently, Prakash Chhabria is the Executive Chairman of the company, and Anil Whabi the CFO.

Finolex Cables (MCap ~Rs 80 bn) holds ~32% stake in Finolex Industries; Finolex industries holds around ~15% stake in Finolex Cables.

Finolex Industries: The Story So Far.. YEAR MILESTONE 1981 Incorporated as PVC pipe manufacturing company. Setup PVC pipe plant at Pune 1985 Pioneered the concept of 'Ringfit' pressure pipes 1994 Set-up a PVC resin plant at Ratnagiri 1999 Started manufacturing PVC pipes at Ratnagiri to meet its growing demand

2006 PVC Resin capacity was expanded from 130,000MT to 260,000 MT. Further expanding its product range, company launched ASTM fittings to its product portfolio

2007 Company introduced underground sewerage pipes

2009 Company started a new unit for manufacturing agriculture pipes and casing pipes at Urse, Pune with the capacity of 28000 MT

2012 Company started a new manufacturing plant at Masar, near Vadodara in Gujarat. 2014-15 Company set up a warehouse at Cuttack (Odisha), Delhi and Indore

2016 Expanded PVC Pipes and Fittings capacity to 280,000 MT Source: Company, HDFC sec Inst Research

Finolex was incorporated in 1981 as a PVC pipes manufacturing company; backward integration took place in 1994, with the setting up of the PVC resin capacity in Ratnagiri. The three main business segments are pipes and fittings, PVC resin and power.t In February 2017, Finolex and Lubrizol Corporation entered into an agreement, for the manufacture and sale of ‘Finolex FlowGuard’ Plus CPVC pipes and fittings in India. Finolex Cables (MCap Rs 86.6 bn) holds around ~32% stake in Finolex Industries; Finolex industries holds around ~15% stake in Finolex Cables.

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Valuation and view At the CMP, Finolex is trading at ~23x FY18E and ~19x FY19E EPS. Given its multiple growth triggers, coupled with huge opportunities in the pipes industry, we argue for a P/E re-rating for Finolex, driven by the following:

Finolex is one of the largest branded players in the organised PVC pipes market in India, enjoying a volume market share of ~19%. The company’s capacity for pipes and fittings stands at 280,000 MT, in an addressable PVC pipes market of 18,00,000 MT, of which only ~60% is organised.

Finolex is backward integrated into the production of PVC resin. This is important as PVC demand in India outpaces supply by ~50%. The company’s PVC resin capacity stands at ~272,000 MT, and 55-60% of the resin manufactured is utilised for captive consumption. This proportion is expected to increase, going forward.

Finolex has recently forayed into the CPVC segment for the manufacture and sale of ‘Finolex FlowGuard’ Plus CPVC pipes, following its arrangement with Lubrizol in Feb 2017. CPVC pipes are typically priced

at a ~25% premium to PVC pipes, which translates into superior margins, as compared to PVC pipes

While the raw material spreads (PVC/EDC) have been favourable in 9MFY17, translating into better margins, we acknowledge that it remains a key monitorable for the company

Initiate with a BUY and TP of Rs 760 (25x FY19E EPS). Our PE multiple at 25x is at a discount to that of its comparable peers.

Risks to our investment thesis

A slowdown in demand, translating to decrease in the growth pace of volumes of pipes and fittings.

A slowdown in the production of PVC resin, which could reduce the proportion of captive consumption.

Volatility in prices of key raw materials such as EDC, VCM and ethylene.

Volatility in PVC prices as well as PVC/EDC spread.

We initiate coverage on Finolex industries with a BUY rating and target price of Rs 760 (25x FY19E EPS)

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Key Assumptions FY15 FY16E FY17E FY18E FY19E

Volumes (MT) Pipes and fittings 185,785 208,763 213,007 244,590 281,319 % YoY 12.4% 2.0% 14.8% 15.0% PVC resin 243,155 248,177 249,505 255,695 262,883 % YoY 2.1% 0.5% 2.5% 2.8% Segment EBIT margin (in %) Pipes and fittings 7.9% 9.0% 8.0% 8.9% 9.5% PVC resin 3.1% 12.7% 20.0% 14.0% 14.0% Source: Company, HDFC sec Inst Research

Valuation Matrix / Peer Comparison

Mcap

(Rs bn) CMP (Rs)

Rating TP

(Rs)

P/E (x) EV/EBITDA (x) P/BV (x) EPS CAGR (%)

(FY16-19E) FY17E FY18E FY19E FY17E FY18E FY19E FY17E FY18E FY19E

Supreme Industries* 151 1185 NR - 36.6 31.3 26.3 20.6 18.1 15.6 9.2 7.7 6.6 23% Astral Polytechnik* 70 589 NR - 51.2 37.7 29.7 28.3 22.2 18.2 7.9 6.7 5.6 33% Finolex Industries 70 563 BUY 760 21.6 22.1 18.5 13.6 14.1 12.0 6.2 5.5 4.8 17%

Source: Bloomberg, HDFC Sec Inst Research *Bloomberg estimates

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Income Statement Year ending March (Rs mn) FY15 FY16 FY17E FY18E FY19E

Net Revenues 24,761 24,528 25,094 28,594 33,039 Growth (%) 0.9 (0.9) 2.3 13.9 15.5 Material Expenses 18,098 16,239 15,056 18,157 20,881 Power & Fuel expenses 740 934 956 1,001 1,156 Employee Expenses 1,125 872 1,079 1,230 1,421 Other Operating Expenses 2,903 2,733 2,789 3,266 3,820 EBITDA 1,896 3,751 5,214 4,941 5,761 EBITDA Margin (%) 7.7 15.3 20.8 17.3 17.4 EBITDA Growth (%) (42.0) 97.9 39.0 (5.2) 16.6 Depreciation 587 506 528 539 552 EBIT 1,309 3,245 4,686 4,402 5,209 Other Income (Including EO Items)

202 636 320 390 461

Interest 704 446 172 82 32 PBT 807 3,435 4,834 4,710 5,639 Tax (Incl Deferred) 330 1,099 1,595 1,554 1,861 Minority Interest & Profit/loss from associates

- - - - -

RPAT 477 2,336 3,239 3,156 3,778 EO (Loss) / Profit (Net Of Tax) - - - - - APAT 477 2,336 3,239 3,156 3,778 APAT Growth (%) (71.9) 389.2 38.7 (2.6) 19.7 Adjusted EPS (Rs) 3.8 18.8 26.1 25.4 30.4 EPS Growth (%) (71.9) 389.2 38.7 (2.6) 19.7


Balance Sheet As at March FY15 FY16 FY17E FY18E FY19E

SOURCES OF FUNDS Share Capital - Equity 1,241 1,241 1,241 1,241 1,241 Reserves 6,633 8,337 10,051 11,465 13,210 Total Shareholders Funds 7,874 9,578 11,292 12,706 14,451 Minority Interest - - - - - Long Term Debt 6,159 2,117 1,317 317 317 Short Term Debt 212 - - - - Total Debt 6,371 2,117 1,317 317 317 Net Deferred Taxes 1,108 1,180 1,000 1,000 500 Long Term Provisions & Others 90 116 120 120 120 TOTAL SOURCES OF FUNDS 15,443 12,992 13,730 14,143 15,388 APPLICATION OF FUNDS Net Block 8,678 8,497 8,668 8,530 8,478 CWIP 104 66 68 77 89 Investments 1,797 2,880 3,000 3,300 3,630 Other non-current assets 588 769 800 850 900 Total Non-current Assets 11,166 12,212 12,536 12,757 13,097 Inventories 5,587 4,472 4,371 5,180 5,955 Debtors 487 176 181 206 238 Loans and advances 1,229 1,231 1,259 1,287 1,487 Cash & Equivalents 123 104 413 396 919 Total Current Assets 7,425 5,983 6,224 7,069 8,599 Creditors 2,000 2,432 2,318 2,747 3,158 Other Current Liabilities & Provns 1,149 2,772 2,712 2,936 3,150 Total Current Liabilities 3,149 5,203 5,031 5,683 6,308 Net Current Assets 4,276 780 1,193 1,386 2,291 TOTAL APPLICATION OF FUNDS 15,443 12,992 13,729 14,143 15,388


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Cash Flow Year ending March (Rs mn) FY15 FY16 FY17E FY18E FY19E Reported PBT 807 3,435 4,834 4,710 5,639 Interest expenses 567 357 172 82 32 Depreciation 587 506 528 539 552 Working Capital Change 492 2,299 (316) (259) (932) Tax Paid (392) (663) (1,595) (1,554) (1,861) Others 61 (290) (320) (390) (461) OPERATING CASH FLOW ( a ) 2,122 5,643 3,302 3,127 2,968 Capex (307) (312) (702) (409) (512) Free cash flow (FCF) 1,815 5,331 2,601 2,718 2,456 Investments 480 (927) (120) (300) (330) Non-operating Income 10 432 320 390 461 INVESTING CASH FLOW ( b ) 183 (807) (501) (320) (381) Debt Issuance/(Repaid) (832) (4,126) (800) (1,000) - Interest Expenses (579) (439) (172) (82) (32) FCFE 404 766 1,629 1,636 2,425 Share Capital Issuance - - - - - Dividend (981) (291) (1,303) (1,489) (1,737) Others (1) - (218) (253) (295) FINANCING CASH FLOW ( c ) (2,392) (4,855) (2,492) (2,824) (2,064) NET CASH FLOW (a+b+c) (87) (19) 309 (17) 523 Opening bal of Cash & Cash Equ 209 122 103 412 395 Closing Cash & Equivalents 122 103 412 395 918 Source: Company, HDFC sec Inst Research

Key Ratios FY15 FY16 FY17E FY18E FY19E PROFITABILITY (%) GPM 26.9 33.8 40.0 36.5 36.8 EBITDA Margin 7.7 15.3 20.8 17.3 17.4 APAT Margin 1.9 9.5 12.9 11.0 11.4 RoE 6.1 26.8 31.0 26.3 27.8 RoIC (or Core RoCE) 4.2 12.6 22.6 19.9 23.0 RoCE 5.7 18.6 25.1 23.0 25.7 EFFICIENCY Tax Rate (%) 40.9 32.0 33.0 33.0 33.0 Fixed Asset Turnover (x) 2.8 2.9 2.9 3.3 3.9 Inventory (days) 82.4 66.6 63.6 66.1 65.8 Debtors (days) 7.2 2.6 2.6 2.6 2.6 Other Current Assets (days) 18.1 18.3 18.3 16.4 16.4 Payables (days) 29.5 36.2 33.7 35.1 34.9 Other Current Liab & Provns (days) 16.9 41.2 39.5 37.5 34.8 Cash Conversion Cycle (days) 61.2 10.1 11.4 12.6 15.2 Debt/EBITDA (x) 3.4 0.6 0.3 0.1 0.1 Net D/E (x) 0.8 0.2 0.1 (0.0) (0.0) Interest Coverage (x) 1.9 7.3 27.3 53.9 164.3 PER SHARE DATA (Rs) EPS 3.8 18.8 26.1 25.4 30.4 CEPS 8.6 22.9 30.4 29.8 34.9 Dividend 7.0 2.0 10.0 10.5 12.0 Book Value 63.4 77.2 91.0 102.4 116.4 VALUATION P/E (x) 146.3 29.9 21.6 22.1 18.5 P/BV (x) 8.9 7.3 6.2 5.5 4.8 EV/EBITDA (x) 40.2 19.2 13.6 14.1 12.0 EV/Revenues (x) 3.1 2.9 2.8 2.4 2.1 OCF/EV (%) 2.8 7.9 4.7 4.5 4.3 FCF/EV (%) 2.4 7.4 3.7 3.9 3.5 FCFE/Mkt Cap (%) 0.6 1.1 2.3 2.3 3.5 Dividend Yield (%) 1.2 0.4 1.8 1.9 2.1 Source: Company, HDFC sec Inst Research

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Rating Definitions BUY : Where the stock is expected to deliver more than 10% returns over the next 12 month period NEUTRAL : Where the stock is expected to deliver (-)10% to 10% returns over the next 12 month period SELL : Where the stock is expected to deliver less than (-)10% returns over the next 12 month period

Date CMP Reco Target 8-May-17 563 BUY 760

RECOMMENDATION HISTORY

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May

-16

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16

Jul-1

6

Aug

-16

Sep-

16

Oct

-16

Nov

- 16

Dec

-16

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17

Feb-

17

Mar

-17

Apr

-17

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-17

Finolex Inds TP

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mailto:[email protected]


HDFC securities Institutional Equities Unit No. 1602, 16th Floor, Tower A, Peninsula Business Park, Senapati Bapat Marg, Lower Parel, Mumbai - 400 013 Board : +91-22-6171-7330 www.hdfcsec.com

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INITIATING COVERAGE 08 MAY 2017 Finolex Industries · INITIATING COVERAGE 08 MAY 2017 Finolex Industries BUY . On a CPVC high . Finolex Industries (Finolex) is a key branded player

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