RESULTS REVIEW 4QFY18 28 MAY 2018

Finolex Industries BUY

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

Pipe business struggles4QFY18 was again a muted quarter for Finolex Industries (Finolex); net revenues stood at Rs 8.09bn (-8.8% YoY). Gross margins improved by 777bps YoY to 41.0% due to better PVC-EDC spreads and inventory gains in line with rising crude prices. This drove up EBITDA margins by 311bps YoY to 23.2%.

The Pipes (& Fittings) segment continues to struggle. Over FY18, this segment has grown vols by 20%, but EBIT/kg has fallen ~37% to Rs 5.3 only. Over FY16-18, Pipes EBIT has fallen from 46 to 28% in the core EBIT mix. PVC EBIT is at a cyclical high, but should command lower valuation multiples, in our view.

We remain positive on Finolex based on (1) The Rising share of (higher profit) non-agri pipes from ~30% in the Pipes mix to ~50% over 4-5 years, (2) Rising CPVC volumes (co aims to quadruple off a small base of just 2% of vols by FY20E). We estimate revenue/EBITDA/PAT CAGR of 12.5/9.6/11.3% hereon.

Notably, Finolex’s Pipes EBIT margin at 5.8% for FY18 is lowest among peers (Skipper/Astral Poly/Supreme Industries 7.0/10.6/11.5%).

We believe competitive environment in pipes segment may not provide enough opportunity for the company to pass on increased cost of raw materials and hence margins may remain under pressure. Accordingly, we have reduced earnings estimates for FY19E/20E by 5.0/13.4% to Rs 27.7/29.8. We have reduced SOTP TP to Rs 801 (vs. Rs 912) including value for investment in Finolex Cables.

Concall Takes Steady ramp-up in capacity: Finolex’s cumulative Pipes

& Fittings capacity stands at 330k MT. The company plans to enhance its capacity to 440k MT, and the complete benefit of the same is expected to accrue by 4QCY20. Of this, ~50k MT could be used for CPVC. The estimated outlay for this expansion is Rs 2.5bn over FY17-20, of which Finolex has invested Rs 1.2bn, and the remaining, will be invested in the next three years.

Financial Summary (Rs mn) 4QFY18 4QFY17 YoY (%) 3QFY18 QoQ (%) FY17 FY18 FY19E FY20E Net Sales 8,091 8,876 (9) 7,227 12 26,024 27,378 31,140 34,633 EBIDTA 1,879 1,785 5 1,133 66 5,631 4,839 5,467 5,810 APAT 1,209 1,233 (2) 695 74 3,522 2,985 3,443 3,696 Diluted adj. EPS (Rs/sh) 9.7 9.9 (2) 5.6 74 28.4 24.1 27.7 29.8 P/E (x) 22.0 25.9 22.5 20.9 RoE (%) 18.2 11.8 12.1 12.2 Source: Company, HDFC sec Inst Research

INDUSTRY PIPES

CMP (as on 28 May 2018) Rs 623

Target Price Rs 801 Nifty 10,689

Sensex 35,165

KEY STOCK DATA

Bloomberg FNXP IN

No. of Shares (mn) 124

MCap (Rs bn) / ($ mn) 77/1,143

6m avg traded value (Rs mn) 61

STOCK PERFORMANCE (%)

52 Week high / low Rs 756/555

3M 6M 12M

Absolute (%) (5.1) (4.8) 5.5

Relative (%) (7.9) (9.4) (7.8)

SHAREHOLDING PATTERN (%)

Promoters 52.47

FIs & Local MFs 8.77

FPIs 4.36

Public & Others 34.40 Source : BSE

Basanth Patil basanth.patil@hdfcsec.com +91-22-6171-7319

FINOLEX INDUSTRIES: RESULTS REVIEW 4QFY18

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PVC Segment: The revenues de-grew by 4.8% YoY to Rs 5.15bn, largely on account of de-growth in volumes (external + internal consumption) (-5.8% YoY to 72,123 tons) and realisation improved by 1.0% YoY to ~Rs 71.5k per ton. The EBIT margins in PVC improved by 332bps YoY to 24.5%, due to favorable PVC-EDC spread and inventory gains due to increase in crude oil prices in Q4FY18.

Pipes & Fittings: The revenues grew by 7.6% YoY to Rs 6.82bn, largely driven by volume growth (+12.2% YoY to 71,758 tons) while realisation declined by 4.0% YoY to ~Rs 95.1k per ton. The EBIT margins in Pipes & Fittings declined marginally by 25bps YoY to 9.0%.

Distribution: Finolex enjoys a pan-India presence, with ~850 dealers and ~18K retail touch points. Almost 50% of the dealers are present in rural areas, and the rest in urban. Finolex had added 150 SKUs for CPVC pipes.

Finolex enjoys a pan-India presence, but operations are largely focussed on South and West India, which contribute 70%+ to the top-line. Company is focused on entering north and east, which we believe will enhance volume growth.

Near-term outlook: The implementation of Prime Minister Awas Scheme, which proposes construction of ~10mn houses by 2019 in the rural areas and ~3.7mn houses in urban areas, provides more opportunity for pipe manufacturers.

FINOLEX INDUSTRIES: RESULTS REVIEW 4QFY18

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Quarterly Financials Snapshot Particulars 4QFY18 4QFY17 YoY (%) 3QFY18 QoQ (%) Net Sales 8,091 8,876 -8.8 7,227 12.0 Material Expenses 4,771 5,924 -19.5 4,856 -1.7 Employee Expenses 298 268 11.0 294 1.3 Other Operating Expenses 1,143 899 27.2 944 21.1 EBITDA 1,879 1,785 5.2 1,133 65.8 Depreciation 156 139 12.4 154 1.5 EBIT 1,723 1,647 4.6 980 75.9 Other Income (including EO) 28 94 -70.5 103 -73.1 Interest Cost 34 11 193.0 (4) -1035.2 PBT 1,717 1,729 -0.7 1,086 58.1 Tax 508 496 2.3 390 30.1 RPAT 1,209 1,233 -1.9 695 73.9 APAT 1,209 1,233 -1.9 695 73.9 Adj EPS 9.7 9.9 -1.9 5.6 73.9 Source: Company, HDFC sec Inst Research Margin Analysis

4QFY18 4QFY17 YoY (bps) 3QFY18 QoQ (bps) Material Expenses % Net Sales 59.0 66.7 (776.9) 67.2 (822.3) Employee Expenses % Net Sales 3.7 3.0 65.6 4.1 (38.8) Other Expenses % Net Sales 14.1 10.1 400.5 13.1 107.0 EBITDA Margin (%) 23.2 20.1 310.8 15.7 754.2 Tax Rate (%) 29.6 28.7 85.9 35.9 (638.1) APAT Margin (%) 14.9 13.9 106.2 9.6 532.5 Source: Company, HDFC sec Inst Research

The drop in revenue was largely on account of de-growth from PVC segment (-4.8% YoY, ~42% of revenues) The improvement in gross margins by 777bps led to improvement in EBITDA margins to 23.2% for the quarter (favorable PVC-EDC spread and inventory gain due to rise in crude oil prices)

FINOLEX INDUSTRIES: RESULTS REVIEW 4QFY18

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Quarterly Segmental Analysis Particulars (Rs mn) 4QFY18 4QFY17 YoY (%) 3QFY18 QoQ (%) Revenue mix PVC 5,158 5,419 (4.8) 4,598 12.2 Pipes & Fittings 6,827 6,344 7.6 5,320 28.3 Power 405 361 12.1 377 7.4

EBIT 4QFY18 4QFY17 YoY (%) 3QFY18 QoQ (%) PVC 1,263 1,147 10.1 802 57.4 Pipes & Fittings 618 590 4.7 296 108.9 Power 15 56 (73.0) 20 (26.1)

EBIT (%) 4QFY18 4QFY17 YoY (bps) 3QFY18 QoQ (bps) PVC 24.5 21.2 332 17.4 703 Pipes & Fittings 9.0 9.3 (25) 5.6 349 Power 3.7 15.5 (1,178) 5.4 (170)

Sales volumes in tons 4QFY18 4QFY17 YoY (%) 3QFY18 QoQ (%) PVC (Internal + External) 72,123 76,541 (5.8) 71,107 1.4 Pipes & Fittings 71,758 63,982 12.2 61,514 16.7 Power in MWH 57,912 53,640 8.0 56,559 2.4

Realisation per kg (Rs) 4QFY18 4QFY17 YoY (%) 3QFY18 QoQ (%) PVC 72 71 1.0 65 10.6 Pipes & Fittings 95 99 (4.0) 86 10.0 Power per unit 7.0 6.7 3.8 6.7 4.9 EBIT per Kg (Rs) 4QFY18 4QFY17 YoY (%) 3QFY18 QoQ (%) PVC 17.5 15.0 16.9 11.3 55.2 Pipes & Fittings 8.6 9.2 (6.6) 4.8 79.1 Power per unit 0.3 1.0 (75.0) 0.4 (27.9) Source: Company, HDFC sec Inst Research

PVC segment deg-grew by 4.8% YoY to Rs 5.15bn, Pipes & Fittings grew by 7.6% YoY to Rs 6.82bn PVC EBIT improved by 10.1% to Rs 1.26bn and EBIT margins enhanced by 332bps YoY, was largely on account of favorable PVC-EDC spread and inventory gain due to rise in crude oil prices

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Pipes And Fittings: Quarterly Trends Trend In Volumes Of Pipes & Fittings Trend In Realisation and EBIT

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

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

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

Pipes & Fittings is a key segment in Finolex, and contributed ~55% to the company’s revenue in 4QFY18 We expect the proportion of higher-margin fittings to gradually increase in the overall volumes of the company The management commentary on discounts for Pipes and Fittings to reduce gradually, hence we anticipate marginal improvement in EBIT per kg to Rs 5.5/5.7 by FY19E/20E

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PVC Resin : Quarterly Trends Trend In Volume Of PVC Trend In Realisation and EBIT

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

Trend In Revenue Of PVC Trend In EBIT and Margin Of PVC

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

PVC segment contributed ~42% of overall revenues for the quarter The EBIT margin for the PVC segment stood at 24.5% in 4QFY18, mainly on account of a favorable PVC-EDC spread which was at USD555/ton PVC EBIT per kg improved by 16.8% YoY to~ Rs 18 per kg in 4QFY18

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FINOLEX INDUSTRIES: RESULTS REVIEW 4QFY18

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Financials Key Assumptions Particulars FY15 FY16 FY17 FY18 FY19E FY20E Volumes (MT) Pipes & Fittings 185,785 208,764 209,419 252,036 299,750 348,117 % YoY 12.4% 0.3% 20.4% 18.9% 16.1% PVC 243,155 248,177 235,103 258,767 270,133 291,850 % YoY 2.1% -5.3% 10.1% 4.4% 8.0% Power (MWH) 165,865 188,788 211,502 208,747 210,834 212,943 % YoY 13.8% 12.0% -1.3% 1.0% 1.0% Realisation (Rs/kg) Pipes & Fittings 91.2 97.3 105.9 92.4 94.2 96.1 % YoY 6.7% 8.8% -12.7% 2.0% 2.0% PVC 64.2 65.6 74.7 68.7 71.5 72.3 % YoY 2.3% 13.9% -8.0% 4.1% 1.0% Power (per unit) 7.9 7.4 6.9 6.8 6.8 6.8 % YoY -6.2% -7.3% -0.5% 0.0% 0.0% EBIT (Rs/kg) Pipes & Fittings 7.2 7.6 8.5 5.3 5.5 5.7 % YoY 6.3% 10.7% -37.3% 4.0% 3.0% PVC 2.0 7.6 15.1 13.1 12.8 12.0 % YoY 285.2% 98.4% -13.2% -2.0% -6.5% Power (per unit) 1.0 1.5 1.6 0.4 0.2 0.2 % YoY 39.4% 6.4% -75.7% -45.9% 0.0% EBIT (Rs mn) Pipes & Fittings 1,337 1,597 1,774 1,339 1,657 1,982 % YoY 19.4% 11.1% -24.5% 23.7% 19.6% PVC 480 1,887 3,547 3,388 3,467 3,502 % YoY 293.1% 88.0% -4.5% 2.3% 1.0% Power 174.0 276.0 329.0 78.9 43.1 43.6 % YoY 58.6% 19.2% -76.0% -45.3% 1.0% Revenues & Margins (Rs mn) Pipes & Fittings 16,938 20,305 22,169 23,288 28,251 33,466 EBIT % 7.9% 7.9% 8.0% 5.8% 5.9% 5.9%

The revenues/EBITDA/APAT expected to grow at a CAGR of 12.5/9.6/11.3% over FY18-20E The management commentary on discounts for Pipes and Fittings to reduce gradually, hence we anticipate a marginal improvement in EBIT per kg

FINOLEX INDUSTRIES: RESULTS REVIEW 4QFY18

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Particulars FY15 FY16 FY17 FY18 FY19E FY20E PVC resin (captive + external sales) 15,601 16,287 17,567 17,784 19,147 21,067 EBIT % 3.1% 11.6% 20.2% 19.1% 18.1% 16.6% Power 1,307 1,395 1,449 1,423 1,437 1,452 EBIT % 13.3% 19.8% 22.7% 5.5% 3.0% 3.0% Total Revenues 33,846 37,987 41,184 42,495 48,836 55,985 Less: Inter-segment transfer 9,085 9,555 11,308 14,181 17,695 21,352 Net Revenues 24,761 28,431 29,876 28,314 31,140 34,633 Source: Company, HDFC sec Inst Research SOTP Valuation methodology Particulars Rs Core Business valued on PE Methodology 24x on FY20E EPS (A) 715 Percentage of holding in Finolex Cables Ltd 14.5% No of shares in Finolex Cables in mn 22.2 CMP of Finolex Cables 687 Market value (Rs mn) 15243 Value per share 123 Holding company discount 30.0% Value per share of Finolex Cables after discount (B) 86 SOTP Value of Finolex Industries (A+B) 801

Source: HDFC sec Inst Research Change In Estimates

Rs mn Previous New % Change

FY19E FY20E FY19E FY20E FY19E FY20E Net Sales 34,537 38,864 31,140 34,633 -9.8% -10.9% EBITDA 5,708 6,685 5,467 5,810 -4.2% -13.1% EBITDA % 16.5 17.2 17.6 16.8 103bps (43)bps APAT 3,624 4,269 3,443 3,696 -5.0% -13.4% EPS 29.2 34.4 27.7 29.8 -5.0% -13.4% Source: HDFC sec Inst Research

We have valued core business on PE methodology (24x on FY20E EPS and assigned a holding company discount of 30% to its holding in Finolex Cables

FINOLEX INDUSTRIES: RESULTS REVIEW 4QFY18

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Peer Valuations

Mcap (Rs bn)

CMP (Rs) Rating TP

(Rs) P/E (x) EV/EBITDA (x) RoE (%)

FY18E FY19E FY20E FY18E FY19E FY20E FY18E FY19E FY20E Supreme Industries 159.4 1,255 NR - 36.9 31.6 25.9 20.5 17.7 14.8 22.7 24.5 25.9 Astral Poly Technik 108.3 904 NR - 61.9 45.3 35.9 39.5 27.7 22.4 18.5 20.8 22.0 Finolex Industries 77.3 623 BUY 801 25.9 22.5 20.9 16.0 13.9 12.8 11.8 12.1 12.8

Source: HDFC sec Inst Research

FINOLEX INDUSTRIES: RESULTS REVIEW 4QFY18

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Income Statement Year ending March (Rs mn) FY16 FY17 FY18 FY19E FY20E Net Revenues 28,431 26,024 27,378 31,140 34,633 Growth (%) 14.8 (8.5) 5.2 13.7 11.2 Material Expenses 20,089 16,096 17,644 20,069 22,320 Power & Fuel expenses 872 706 753 779 866 Employee Expenses 925 1,049 1,161 1,183 1,247 Other Operating Expenses 2,501 2,542 2,980 3,643 4,391 EBITDA 4,044 5,631 4,839 5,467 5,810 EBITDA Margin (%) 14.2 21.6 17.7 17.6 16.8 EBITDA Growth (%) 113.4 39.2 (14.1) 13.0 6.3 Depreciation 506 550 606 593 601 EBIT 3,539 5,080 4,233 4,874 5,209 Other Income (Including EO Items) 641 243 253 292 318

Interest 447 154 98 105 94 PBT 3,733 5,170 4,388 5,061 5,433 Tax (Incl Deferred) 1,189 1,648 1,403 1,618 1,737 Minority Interest & Profit/loss from associates - - - - -

RPAT 2,544 3,522 2,985 3,443 3,696 EO (Loss) / Profit (Net Of Tax) - - - - - APAT 2,544 3,522 2,985 3,443 3,696 APAT Growth (%) 432.8 38.4 (15.2) 15.3 7.3 Adjusted EPS (Rs) 20.5 28.4 24.1 27.7 29.8 EPS Growth (%) 432.8 38.4 (15.2) 15.3 7.3

Source: Company, HDFC sec Inst Research

Balance Sheet Year ending March (Rs mn) FY16 FY17 FY18 FY19E FY20E SOURCES OF FUNDS Share Capital - Equity 1,241 1,241 1,241 1,241 1,241 Reserves 14,458 21,673 26,405 28,048 29,945 Total Shareholders Funds 15,698 22,914 27,646 29,289 31,186 Minority Interest - - - - - Long Term Debt 1,117 942 1,007 907 807 Short Term Debt - - - - - Total Debt 1,117 942 1,007 907 807 Net Deferred Taxes 1,205 1,316 1,207 1,207 1,207 Long Term Provisions & Others 644 728 782 782 782 TOTAL SOURCES OF FUNDS 18,664 25,900 30,642 32,185 33,982 APPLICATION OF FUNDS Net Block 8,496 8,551 8,842 8,550 8,249 CWIP 66 217 903 1,028 1,143 Investments 6,363 11,549 14,896 14,896 14,896 Other non-current assets 698 1,835 1,810 1,810 1,810 Total Non-current Assets 15,624 22,153 26,452 26,284 26,098 Inventories 4,472 5,574 6,116 6,544 7,258 Debtors 176 525 431 474 525 Loans and advances 1,231 465 656 746 830 Cash & Equivalents 1,913 837 890 2,310 3,898 Total Current Assets 7,792 7,400 8,093 10,074 12,511 Creditors 2,432 2,275 2,505 2,863 3,175 Other Current Liabilities & Provisions 2,319 1,378 1,399 1,309 1,451

Total Current Liabilities 4,751 3,653 3,904 4,172 4,627 Net Current Assets 3,041 3,748 4,189 5,902 7,884 TOTAL APPLICATION OF FUNDS 18,664 25,900 30,642 32,185 33,982

Source: Company, HDFC sec Inst Research

FINOLEX INDUSTRIES: RESULTS REVIEW 4QFY18

Cash Flow Year ending March (Rs mn) FY16 FY17 FY18P FY19E FY20E Reported PBT 3,435 5,170 4,388 5,061 5,433 Interest expenses 357 115 98 105 94 Depreciation 506 551 606 593 601 Working Capital Change 2,299 (1,531) (497) (293) (394) Tax Paid (663) (1,752) (1,403) (1,618) (1,737) Others (290) (211) (253) (292) (318) OPERATING CASH FLOW ( a ) 5,643 2,342 2,939 3,556 3,679 Capex (312) (936) (1,583) (424) (415) Free cash flow (FCF) 5,331 1,406 1,356 3,132 3,264 Investments (927) 1,229 (3,348) - - Non-operating Income 432 186 253 292 318 INVESTING CASH FLOW ( b ) (807) 479 (4,678) (132) (97) Debt Issuance/(Repaid) (4,126) (1,174) 65 (100) (100) Interest Expenses (439) (162) (98) (105) (94) FCFE 767 70 1,323 2,927 3,070 Share Capital Issuance - - - - - Dividend (291) (1,474) (1,489) (1,799) (1,799) Others 1,038 (1,088) 3,315 - - FINANCING CASH FLOW ( c ) (3,817) (3,897) 1,793 (2,005) (1,994) NET CASH FLOW (a+b+c) 1,019 (1,077) 54 1,419 1,589 Opening bal of Cash & Cash Equivalents 894 1,913 836 890 2,310

Closing Cash & Equivalents 1,913 836 890 2,310 3,898 Source: Company, HDFC sec Inst Research

Key Ratios FY16 FY17 FY18P FY19E FY20E PROFITABILITY (%) GPM 29.3 38.1 35.6 35.6 35.6 EBITDA Margin 14.2 21.6 17.7 17.6 16.8 APAT Margin 8.9 13.5 10.9 11.1 10.7 RoE 21.6 18.2 11.8 12.1 12.2 RoIC (or Core RoCE) 27.5 35.0 23.1 23.3 24.8 RoCE 16.7 16.3 10.8 11.2 11.4 EFFICIENCY Tax Rate (%) 31.8 31.9 32.0 32.0 32.0 Fixed Asset Turnover (x) 3.3 3.1 3.1 3.6 4.1 Inventory (days) 57 78 82 77 76 Debtors (days) 2 7 6 6 6 Other Current Assets (days) 16 7 9 9 9 Payables (days) 31 32 33 34 33 Other Current Liab & Provi (days) 30 19 19 15 15 Cash Conversion Cycle (days) 28 54 54 49 49 Debt/EBITDA (x) 0.3 0.2 0.2 0.2 0.1 Net D/E (x) (0.1) 0.0 0.0 (0.0) (0.1) Interest Coverage (x) 7.9 33.0 43.1 46.3 55.2 PER SHARE DATA (Rs) EPS 20.5 28.4 24.1 27.7 29.8 CEPS 24.6 32.8 28.9 32.5 34.6 Dividend 2.0 10.0 11.5 12.0 14.5 Book Value 126.5 184.6 222.8 236.0 251.3 VALUATION P/E (x) 30.4 22.0 25.9 22.5 20.9 P/BV (x) 4.9 3.4 2.8 2.6 2.5 EV/EBITDA (x) 18.9 13.7 16.0 13.9 12.8 EV/Revenues (x) 2.7 3.0 2.8 2.4 2.1 OCF/EV (%) 7.4 3.0 3.8 4.7 5.0 FCF/EV (%) 7.0 1.8 1.8 4.1 4.4 FCFE/Mkt Cap (%) 1.0 0.1 1.7 3.8 4.0 Dividend Yield (%) 0.3 1.6 1.8 1.9 2.3

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-17 562 BUY 760

29-May-17 598 BUY 765 13-Nov-17 696 BUY 861 12-Jan-18 665 BUY 900 15-Feb-18 654 BUY 861 11-Apr-18 657 BUY 912 28-May-18 623 BUY 801

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17

Jul-1

7

Aug-

17

Sep-

17

Oct

-17

Nov

-17

Dec-

17

Jan-

18

Feb-

18

Mar

-18

Apr-

18

May

-18

Finolex Inds TP

FINOLEX INDUSTRIES: RESULTS REVIEW 4QFY18

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FINOLEX INDUSTRIES: RESULTS REVIEW 4QFY18

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