Finolex Cables: Strong Brand Equity:: Sushil Research

STRENGTH: Strong Brand Equity, Vast Distribution Network, Healthy Balance Sheet, Strong Operating Cash-Flows
WEAKNESS: Dependency on Govt. Reforms in Power & Telecom Sector
OPPORTUNITIES: Diverse End-user Industries, Turnaround of New Ventures (CFL & Switches)
THREAT: Increasing Competition from Unorganized Players, Volatility in Copper Prices & Currency.

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Strong Brand Equity, Wide Product Application Coupled with Vast Distribution Network to drive Product Demand
FCL is one of the leading players in the cable industry (~90% of revenue) having wide product portfolio of over 4,500 SKU’s. Superior quality products, new innovations coupled with continuous product improvement has enabled FCL to create strong brand equity giving it a competitive edge over its peers. Wide application of its products (Electrical & Communication cables) in various segments i.e. Auto, Construction, Pumps, Motors, Consumer Electrical Goods, Power Distribution, Telecom, Networking etc. offers huge & diverse end-user industries. Moreover, improving government initiatives in power & telecom segment could provide further impetus to demand for its products. Gradual capacity expansion along with better capacity utilization of existing capacities provides enough room to cater to rising demand. The Company is doubling its capacity at Roorkee plant (majorly into electrical cables & contributes ~50% of total capacity) over the next 12 months with an overall capex of ~Rs.800 mn. Also, FCL’s vast distribution network of over 2,500 Channel partners & 20,000 dealers not only facilitate pan-India presence but also help them to leverage the same network for its new upcoming products like CFL & Switches.
Derivative Losses – No More a Major Overhang
In order to hedge the financial risk associated with its business, the FCL had indulged into exotic derivative contracts in the past which however due to adverse currency movements resulted in huge losses. Since FY08, the Company had been incurring derivative loss which cumulatively stands at ~Rs.2.8 bn. However, considering bitter past experience coupled with change in top management in FY09, FCL changed its strategy & since then have been successful in lowering its derivative exposure & losses. Derivative exposure in FY08 stood at ~Rs.16.5 bn which got reduced to ~Rs.0.2 bn in FY12 while losses have come down from ~Rs.1.1 bn in FY09 to ~Rs.0.3 bn in FY12. The management expects to get rid of the last derivative contract in FY13 (loss ~Rs.0.2 bn) with no future intent of entering into similar contracts.
Healthy Balance-sheet, Expanding Return Ratios with Strong Dividend Track Record
Despite ongoing capex & huge derivative losses, the Company has been able to reduce its D/E from ~0.5x (FY09) to ~0.2x (FY12) which was majorly due to its decent operating cash flows. However, with derivative losses coming to an end in FY13E and likely better operating performance in the coming years, we expect cash flows to improve going ahead. Net profit is expected to grow at ~28% CAGR over the next 2 years resulting in expanding ROE & ROCE which we expect to improve from 13% & 14% to 16% & 19% respectively. It also has a strong dividend track record since it has been consistently paying dividend for more than 20 years (Average payout over the last 3 years ~12-15%). OUTLOOK & VALUATION FCL being one of the leading players in the cable industry seems well placed to capture huge opportunities considering the strengths & the industry in which the Company is operating. Derivative losses coupled with bleak performance by communication cable segment were the major reasons for de-rating of the stock in past which in our view seems to have been overdone. However considering the sharp run-up in the price, we change our rating to HOLD with a target price of Rs.68 while maintaining our positive view on the stock. We have assigned a multiple of 6.5x FY14E earnings which is lower than 3-year average of ~7.5x despite the worst getting over for the company