Kamlesh Kotak

When a stock yields an astounding 14x return in five years, one tends to believe that the story has largely played out. Naturally, the logical thing to do would be to take the profit off the table and bet on yet another fundamentally sound stock. But you may not want to do with Pune-based Finolex Cables just yet. In fact, investors who bought the stock a year ago, are sitting on a cool profit of 60% and counting.

Continued capacity expansion, market share gain, excellent working capital management with a cash-n-carry revenue model in a highly commoditised business have helped Finolex turn cash-rich from being debt-ridden. All of this happening within a span of five years has fuelled much of the re-rating.

Back with a bang
Over its 48-year-long existence, Finolex has always been operationally profitable even through the financial meltdown in 2008 when the company got saddled with huge forex losses. Finolex used to import copper, the primary input that goes into cables and wires. The forex derivative contracts it had entered into, with the aim to hedge against currency and commodity volatility, worked against the company as copper prices tumbled and as did the rupee. Over FY09-13, the company had to take a write-off of Rs.250 crore on account of the forex losses. It didn’t help that the debt on books piled up to Rs.300 crore.  Nevertheless, along with the management change, the company also initiated a major business realignment exercise. First, to avoid forex risks, it decided never to enter into complex derivative contracts and hedge its forex position only through simple hedging contracts. Secondly, it commissioned a new plant (the third after Pune and Goa) in Uttaranchal to cater to the markets in the north. Thirdly, it entered into a 50:50 venture with J-Power systems Corporation of Japan, a wholly owned subsidiary of Sumitomo Electric Industries of Japan, by investing Rs.100 crore to set up an extra high voltage cables plant to manufacture 132 kv and 220 kv cables.

These initiatives paid off as the earnings grew at an average of 28% CAGR over FY10-16. Over the last decade, the company invested Rs.590 crore in adding capacities. Cumulative cash from operations for the decade stood at staggering Rs.1,600 crore, of which Rs.600 crore is sitting in form of cash and liquid investments. return on average capital employed and return on equity improved to 23.3% and 18.2%, respectively, in FY16 from 17.1% and 12.9% in FY12.

Creating a niche 
Finolex is one of the few companies to have a only ‘product’ business with a diversified presence across housing, industrial, infrastructure (power), telecom (optic fibre cables), consumer goods (lighting, fans, switch gear) and agriculture (through its pump rewiring business and a 32% stake in Finolex Pipes). Though the company’s foray into lighting and switches has not met with any great success, its business of wires and cables has outperformed its peers. Finolex sells its products on cash-n-carry model, hence, its cash conversion cycle is at an impressive 22 days. What is remarkable is that the fact that Finolex even managed to outperform Havells, the market leader in the electric wires and cables business on all three important parameters: growth, profitability and return ratios. Over FY07-FY16, Finolex’s electric wires and cable business grew at 12.4% CAGR compared with 12.3% CAGR for Havells’ cables business. FY16 EBIT margin of 16% and RoCE of 90% for Finolex’s cables business outpaced 14.2% EBIT margin and RoCE of 82%, clocked by Havells cable division.

Of Finolex’s total revenues of Rs.2,543 crore in FY16, 82% came from the electric wires and cable business, 14% from telecom cables and rest 4% from copper rods, lighting and switches. Within electric wires and cables, Finolex has a diverse presence across five segments which holds it in good stead when a particular segment witnesses a downcycle. 

Room for growth
The domestic wires and cables market is estimated to be Rs.24,000 crore with top 10 players making up for around 55% of the market. Both Finolex and Havells have a market share of 9% with almost similar revenues of over Rs.2,000 crore each, next to the overall industry leader Polycab (market share of 17%). The industry has over 200 small and medium sized producers whose products are about 10-20% cheaper, making the industry a very competitive and commoditised one. However, organised players have been able to consolidate their position owing to a shift in the consumers’ preference towards branded and quality products. Being a core product, used across many sectors such as housing, engineering, consumer goods, construction, railways, capital goods and infrastructure, the wires and cables industry is poised for a healthy growth in the coming years. 

Finolex Cables’ telecom cable business (manufactured at the Goa plant) also appears promising considering the government’s thrust on digitisation. Finolex is a leading manufacturer of optic fibre cables after Sterlite and Birla Cable. To strengthen the business, Finolex entered into a marketing JV with Corning USA for procuring and marketing optical fibre. The telecom business currently contributes around Rs.220 crore and the management believes that the business has potential to grow two-fold over the next three to four years. 

Moving from a B2B model, Finolex has now entered the consumer facing business of fans and switchgears in the current fiscal. The management expects the businesses to generate revenue of Rs.200 crore over the next three years. While the shift from a B2B to a B2C model may not be easy, Finolex has a strong balance sheet to spur its marketing spend as the company makes the transition. The current marketing spend at Rs.14 crore (less than 1% of revenue) is very small compared with those of its peers.

The story’s not over yet
Finolex has demonstrated excellent execution capabilities by making its business model more capital efficient and following a disciplined capital allocation approach. While the initiatives in form of new businesses viz fan and switchgear and commissioning of extra high voltage cables business (product approvals and certification awaited) will need some monitoring as far scaling up and profitability goes, the core business is on a strong footing. We believe the company has ample growth opportunities by leveraging its strong brand equity, expansive reach and robust balance sheet. Apart from its cash pile of Rs.600 crore, it also holds a 32% equity stake in group company Finolex Industries at a cost of Rs.150 crore but whose valuation at current market prices is pegged at Rs.1,700 crore. We expect revenues and net profit to clock a CAGR of 14% and 20% over FY16-18. 

The stock currently trades at 19x its estimated FY18 earnings and at discount to peers Havells, Crompton Greaves Consumer Electricals and V-Guard, all of which are trading in the band of 28x-30x estimated FY18 earnings. We believe the stock has enough steam for investors wanting to take a long-term bet.

The brokerage firm has a buy call on the stock for its clients, but the writer, in his personal capacity, does not own the stock