Piping growth

INVESTMENT COUNTER/ PENNY WISE

A 56 per cent rise in stock price over the past year, when the index itself surged by nearly 90 per cent, may be nothing to brag about.

However, a near 270 per cent jump in net profit (Rs 35.77 crore) for the fourth quarter of FY04 is sure to attract attention. That is what Finolex Industries (FIL), India's largest PVC (poly vinyl chloride) pipe manufacturer, achieved in the last quarter, though it must be noted that the growth in profitability was driven largely by a huge spurt in other income.

Analysts are, however, optimistic on the company's prospects on account of an upswing in global petrochemical industry coupled with increasing domestic demand for PVC pipes.

FIL, formerly Finolex Pipes, was incorporated in 1981 and is part of the Finolex group. Beginning as a PVC pipe manufacturer, the company, promoted by P P Chhabria, went for backward integration and now manufactures PVC resins, too.

Expanding delta drives growth
The company recorded a 16.30 per cent rise in net sales to Rs 226.95 for the quarter ended March 31, 2004, on the back of strong trends in PVC prices and higher demand.

Its operating margins also improved to 31.43 per cent compared to 19.58 per cent during the same period last year. FIL's performance for FY04 was also impressive.

While net sales improved 13.70 per cent to Rs 845.56 crore, net profit jumped to Rs 90.16 crore, a rise of 12.15 per cent, again driven by a big spurt in the other income component due to treasury profits and gains on foreign exchange worth Rs 8 crore booked in the last quarter.

However, operating margins took a hit for FY04 on account of poor results during the first half when the company was faced with rising ethylene di-chloride (EDC) and falling PVC prices in the aftermath of the Gulf War and SARS. FIL has recommended a total dividend of 30 per cent (Rs 3 per share) for FY 2003-04.

According to analysts, the improved performances have come on the back of strong trends in international prices of PVC during 2004 and an expanding delta (the difference between prices of PVC and its main raw material, EDC).

"The profitability growth has mainly been due to the fact that delta has expanded. The run-up in PVC prices has not matched the EDC prices," says Nitin Khandkar, vice president for domestic securities firm, East India Securities.

The company depends heavily on imported EDC for the manufacture of PVC. And its built-up inventory is expected to bring about a further improvement in margins going forward.

PVC demand on the rise
The growth story is not just about prices though. Strong demand has also played its part in improving the company's topline. According to analysts, demand for FIL's main products - PVC resins and PVC pipes - is very strong.

The company's PVC resin business grew 4.50 per cent in volume terms in FY04. FIL is second only in market share to the Reliance-IPCL combine which is the leader in PVC business with about 64 per cent of the total capacity. Finolex is the next with 16 per cent while the rest is split between DCW, Chemplast, and DCM Shriram.

FIL's PVC resin plant contributed 72 per cent to FY04 turnover while the contribution from the PVC pipe business stood at 28 per cent. The demand growth for PVC pipes has mainly stemmed from the agricultural sector.

A good monsoon and increased emphasis on drip irrigation by various state governments have also contributed to the spurt in demand for pipes, note analysts.

Rising demand has also led the company to increase its PVC pipes manufacturing capacity from 49,000 metric tonnes per annum (mts p.a) to 62,500 mts p.a. Analysts expect that with the expansion FIL would be able to cater to the pending demand in rural markets.

FIL is also planning to expand the capacity at its PVC plant at Ratnagiri to 280,000 tonnes from 130,000 tonnes at an outlay of Rs 500 crore. FIL's PVC plant enjoys many locational advantages, the important one being proximity to the market.

Further, FIL's group companies consume about 45,000 metric tonnes of PVC per annum, which makes sure there is no risk of an inventory pile-up.

Expanding for growth
Traditionally, Finolex has been strong in the southern and western markets and has a market share of more than 25 per cent in PVC pipes. But increasing opportunities mean the company must be looking elsewhere to sustain growth.

FIL has set sights on the lucrative northern markets for growth. It also has the advantage of a network of more than 2,000 dealers spread across the country.

The company's brand name is also a positive factor, especially in the PVC pipe segment where it is the number one player in the industry. "The brand equity of Finolex in PVC pipes is unmatched," says Khandkar.

However, there is stiff competition from regional players. According to Khandkar, ultimately it's the quality of products that is tilting the balance in FIL's favour. Even though there are a lot of regional players in the unorganised sector, the quality of their products may be suspect.

The outlook is bright
So what does the future hold? According to Khandkar there is no apparent threat to the FIL saga, at least not in the near future. "There is no immediate threat to the future since domestic demand far exceeds capacity," he says. And the built-up inventory of raw materials like EDC will mean that costs will remain depressed, thus improving margins.

"The outlook for PVC industry is positive at least for the next two years," says Khandkar.

The global demand for PVC resins is expected to rise at 4 per cent per annum compared to an increase in capacity by 2.5 per cent over the next five years. Analysts expect Indian demand for PVC to go up by more than 10 per cent per annum over the next five years.

The demand for PVC pipes in India is also expected to explode in the coming years. Various initiatives by central and state governments for drinking water supply, sanitation and irrigation are resulting in a strong demand growth in the segment.

Micro irrigation projects by state governments will give a boost to the industry, say analysts. The availability of agricultural loans at low interest rates is also expected to result in high demand for agricultural inputs like PVC pipes.

Another factor that should result in higher demand is the fact that the usage of PVC pipes in construction is also on the rise.

While the outlook remains positive, FIL's story may not be without glitches going forward. The unpredictable nature of the petrochemical industry is a definite concern, with any slip in petrochemical prices expected to affect profitability of the company. And if rain Gods don't smile as they did in 2003, rural demand can prove a drag.

But things look bright for the time being. "I am bullish on the stock," says Khandkar, noting that FIL's valuations are modest. Khandkar projects an FY05E EPS of Rs 9 (FY04 EPS - Rs 7.25) and a P/E of 6x.

The stock currently trades at Rs 58.35, at a P/E of 6x. Keeping in mind the demand supply gap that exists in the PVC resin business and the strong outlook for PVC prices, the stock is definitely worth a look in the medium term, note analysts.