Finolex Industries-Multi-Bagger

 

(Finolex Ind gets single digit PEs while similar manufacturers like Sintex and Astral Poly get twice the PEs. This under-valuation cannot sustain for long. Finolex Ind is ready for a re-rating)

 

There has been a significant increase in the disposable income of the Rural population, driven by the various government schemes. An improvement in the cash position has allowed the rural population to reinvest in their farm land and to build concrete houses, which are the two top priorities in Rural India. The impact of NREGA has been that middle class living in rural and sub-urban India has created additional demand for PVC pipes-which grew 30 per cent in FY10, and this momentum is likely to continue.

 

Finolex Industries is the largest integrated PVC pipe manufacturer in the country with a capacity of 140,000 MT which is expected to increase by another 50,000 MT in FY11.

 

Finolex Ind offers a wide range of PVC pipes and fittings for diverse applications in agriculture, housing, telecom industry. It also manufactures speciality pipes and fittings for the construction industry. Currently, 75 per cent of sales are made to the Irrigation sector.

 

Finolex has aggressive plans to capture incremental market share in Northern India, where the demand for PVC pipes is growing at a high pace mainly driven by the construction, with demand forecast to grow by 35 to 40 per per annum over the next 5 years.

 

Besides growth in sales volume growth, Finolex Industries will be saving massively on input cost, where captive power will help reduce power cost from 10 per cent of Sales in FY09 to 4 per cent in FY11. This will be the biggest contributor to margin improvement in FY11.

 

Finolex Industries is also present in the drip irrigation business through it's joint venture-which is growing at an exponential pace. During FY10, this JV grew revenues by 67 per cent yoy and returnedEBITDA margins of 30 per cent. Value unlocking through a listing of this entity over the next 3 years is a distinct possibility.

 

Most importantly, Finolex has shifted one of it's production facilities to Ratnagiri. The said facility was located on a piece of land admeasuring 78 acres and situated in Pune. There are plans to sell this land and close-out corporate debt. The land sale should bring in Rs 410 crore or roughly Rs 33 per share. Adjusted for this land sale, the Finolex Industry stock is available for a mere Rs 50 per share.

 

The management is confident of clocking a net CAGR earnings of 22 per cent for the period FY10-FY12, primarily driven by higher volume growth in the pipes business coupled with robust margins backed by huge power cost savings.

 

At the current price, Finolex is quoting at 5 and 4 times EV/EBITDA for FY11-FY12. The stock also offers a near 4 per cent Dividend yield.

Careful of Low Valuation Stocks!!

Many stocks are trading at highly attractive valuations;  basically low price to earning (PE) multiple or high book value (BV) compared with market price.  It could be due to various reasons such as poor financial performance, operational difficulties, company specific problems, hostile business environment and contingencies and so on.  In such case, attractively valued PE stocks could be a fatal for less informed retail investors.  Investors should stay away from mysteriously attractive valuations unless they know the real reason behind this.

Quality stocks always come at a premium to peer groups.

Investors can easily spot companies that are loss making and trading at pathetically dismal valuation considering their turnover and asset.  Loss could be one reason for low valuation, but not everything.  However, one critical lesson for retail investors is that focus on management quality and corporate governance.  There are many ways to trace companies that are commanding low valuation due to corporate governance.  The following could few for low stock valuations:

·         Stocks posting excellent numbers but trading at at low valuations.  Why are investors not offering rich valuation if the numbers are so robust.  The reason could be dubious management.

·         Continuous underperformance of stock year after year.  This could be a pointer towards corporate governance issue. 

·         Look at institutional shareholding to understand whether the company is worth investing.  Declining institutional interest should be treated as an early warning by retail investors.

·         Companies reporting very high EPS but paying low dividends without any justifiable reason such as major capital expenditure plan.

·         Companies with promoters owning less than 26% and reporting robust earning, and thus, low PE multiple.  Promoters need 26% equity stake in a company to pass simple resolution and enjoy management control over a firm.  If companies are doing so well and simultaneously available at low valuation, why are such companies not subject to hostile takeover?  The simple reason is such companies have no value and competitors know this fact very well.  Therefore, carefully scan companies were promoters have little stake but have no excellent financial numbers to show.

·         Adverse comments made by the statutory auditors in recent past.  If the statutory auditors are not comfortable with the financial presented to them, why should shareholders trust those numbers??

·         Exodus of independent directors from the board of directors

Investors should make efforts to dig reasons for the alluring valuations.  Remember nothing comes cheap.

Find Some Growth Stocks Where Ratios Will Not Work

Some of the companies with negligible revenue from core business but mega plans under implementation are worth look. 

The Price to Sales Ratio is a valuation ratio that indicates how much investors are ready to pay for each rupee of sales.  It can be calculated as the market capitalization divided by sales.  The one with low ratio is considered as value pick.   However, the price to sales ration can not always be considered to pick the growth stocks.  In recent results, a few companies have little or nothing to show by way revenue and profit from their core business operations.  Many of these companies have mega future plans that could completely transform companies’ business profile and size of operations.  Such stocks are difficult to value as traditional parameters such as earning per share, price to earning multiple, dividend yield etc.

Some of them also present huge opportunities and these stocks could be multibaggers once project starts going on stream.  Investing in such stocks makes sense before their core business goes on stream and start contributing to the top line as immediately after this as it is most likely that such stocks would witness re-rating.  Generally, such stocks rally once plans start materializing or at least some visibility emerges on project implementation.

Investors should be clear on two fronts: first, these stocks are long term bests and there is no point expecting overnight results.  Second, before investing in such companies, investors should make some basic checks like management credentials, project implementation skills, experience, corporate governance norms, financial backing by group, industry dynamics and size of the business opportunity and so on.

One can look at the following companies from power sector can for long term investment:

·         Adani Power: Projects are under implementation for 10000MW.

·         Reliance Power: 16 large projects, combined capacity of 33,480MW

·         Indiabulls Power: 6,600 MW (thermal power), 167MW (Hydropower)

·         KSK Energy Ventures: Nine plants are under implementation with combined capacity of 8,900 MW

·         NHPC: 11^th plan target is 5322 MW.

·         Jaiprakash Hydro Power: Plans to add power generation capacity of 13,500 MW (mix of thermal & hydro).

This investment is only for the bravehearts who can take the risk of losing entire capital.  This is because project implementation is dicey and could lead even to company’s fall,  long gestation, project delays, funding issues, regulatory and policy issues, pricing barriers, market entry, volatile commodity prices etc.

Raising Capital: Why Promoters Go for QIPs & Preferential Issues??

Qualified Institutions and Placement (QIP) and Preferential Allotment are quickest, easiest and cost effective ways of raising capital, and therefore, the promoters prefer these routes over the time consuming rights issues or follow-on offers.

Rights issue and follow-on issues are mainly bogged down by lengthy, tedious and time consuming procedures, while QIP and preferential allotment are less time consuming as that do not require submitting and seeking approval of issue prospectus as in the case of right issue.  A placement document is required to be submitted with stock exchanges were shares are to be listed against full fledged issue prospectus for right issues.

In QIP, no prior regulatory approval is required for issue document placed with QIBs, which are basically institutional investors.  The assumption is that institutional investors, to whom the shares are offered, are supposed to be well informed investors and a detailed prospectus approved by the regulators is not needed.

Besides QIP, many companies have raised money in the recent past through Preferential Allotment of shares to promoters and strategic investors as well.  The purpose of allotting preferential shares to promoters is to maintain promoters stake at a comfortable level post equity dilution through QIP issue.

One of the reasons for introducing QIP was to invite risk takers to the market.  A company that wants to come out with an IPO and list has to fulfill certain basic criteria such as profitability track record, net worth and so on.  Companies in certain industries such as direct-to-home and airlines where gestation period is long, will not able to float an IPO due to the non-fulfillment of the eligibility conditions.  To allow such companies to raise money from the stock market, the Disclosure and Investor Protection Guidelines allowed them to float IPO provided 50% of shares are reserved and allotted to Qualified Institutional Buyers.

It is not only promoters, but even institutional investors prefer QIP and Preferential Allotment.  This is because if institutional investors decide to buy shares from the open market in bulk, the price of the stock shoots up. They are saved from this possible impact cost when he buys a stake through QIP or Preferential Allotment.

QIPs & Preferential issues have flexible structure.  QIP is popular because the issuer can use other financial instruments convertible into equity shares, except warrants.  Preferential issues allow companies to allot optional convertible warrants.  Optionally convertible warrants are not available to QIBs.  However, preferential issues come with a lock-in period, while QIP has no lock-in, with the only condition that shares should be sold through the recognized stock exchanges. 

With companies favoring QIP and preferential allotment, small and retail investors are being deprived of opportunities to invest in such companies.  Suppose retail investor is holding shares of a company about whom he is confident.  He is convinced about its future prospectus and would like to hold these shares for long term.  Now if the company wants to raise additional equity capital the retail investor is on losing side.  This is because, he is being deprived of the investment opportunity in favor of a handful of institutional investors and promoters.

How Important is to Know Changes in Promoters’ Holding

Many promoters have increased/decreased their equity stake last recent quarters.  Reviewing the change in shareholding pattern, specially that of promoters, could be useful to the investors. As a rule of thumb, higher promoters stake is perceived as positive and a lower equity stake could mean low confidence of promoters in their own company.  Rise in promoter stake is considered positive as promoters will commit additional fund only when they are optimistic about future growth of their company. 

Rise or fall in promoters holding is to be studied by looking at two aspects, First what is purpose of promoters in raising or reducing their equity stakes, second, the methods promoters have adopt to increase or reduce their ownership.

An increase in promoter stake does not always constitute a sign of confidence.  It is also necessary to see whether fresh funds have come in.  If fresh fund have been invested, where will there be invested.  Answers to these questions would help investors to determine whether jump in promoter stake is beneficial to the company. 

In few cases, promoters put in additional funds to retire debt and strengthen their balance sheet.  This is certainly positive for the shareholders. 

Similarly, companies that have gone for share buy back also see rise in promoters stake.  The core objective of a buyback is to create wealth, but it also increases promoters equity stake at no additional cost.

On the contrary, when companies that have opted for rights issues promoters forced to step in to bail out the unsubscribed portion, there is an unintentional rise in promoters stake.  Shareholders declining to subscribe to rights issue and promoters chipping to rescue the issue does not qualify to be positive development. 

Similarly, a decline in promoter holding should also be analyzed in detail.  Decline in promoter holding can be due to various factors such as fresh issues of equity shares to non-promoters through QIB, offer of GDRs and so on.  Also, it could be due to reason such as issuing fresh share towards employee stock option, or it could be due to offloading/issuing of fresh shares to strategic/financial partners.

Many companies have garnered financial resources through offloading fresh equity shares to QIB (Qualified Institutional Buyers).  As a matter of fact, QIBs have helped many companies to remain afloat during difficult times of 2009.

However, promoters offloading their holdings in the open market is a warning signal.  Some dubious companies announce positive development periodically, promoters keep on offloading equity stake at the same time.  It is well laid-out trap for investors.

While studying the change in shareholding pattern, particularly that of promoters, it is imperative for investors to establish whether it is beneficial to the company.  For instance, cash coming into the business is positive for company.   However, rise in promoters stake due to merges or buyback means little for investors in real terms. 

Establishing whey promoters’ equity stake has gone up or down is not an easy task in many mid/small companies.  Therefore, investors have to be cautious and find out the nature of transaction that has led to change in promoters holdings.

Jet, Godrej to ink Mumbai land deal soon

Jet Airways and Godrej  Properties are in the process of signing a deal for developing Jet’s land in the Bandra Kurla Complex area of Mumbai together.  The deal is expected to conclude within two weeks, they said.

Jet Airways  had purchased a 2.5-acre plot from the Mumbai Metropolitan Region Development Authority in March 2008 for Rs 826 crore (Rs 8.26 billion) for developing its global headquarters. However, the airline did not go ahead with the plans and started negotiations to sell off the land.

The initial term sheet agreement between the companies is likely to allow Jet to retain 250,000 square feet as required by the MMRDA and the carrier will pay around Rs 320 crore (Rs 3.2 billion) for the retained portion. Jet Airways and Godrej Properties’ profit sharing ratio is likely to be in the range of 45-50 per cent from the sales of the remaining 1.1 million sq ft.

Godrej Group Chairman Adi Godrej, in a concall, said, “On the Jet Airways deal… it is work in progress, negotiations are going on.

“As and when it is concluded, we will make an announcement. We need to get 10 million square feet in a short number of years in order to execute all our present and future programmes that we will take into account. Hopefully, we can exceed 10 million square feet per year in course of time.”

Thangamayil Jewellery bet overseas market??

Mumbai-based HNIs have been buying shares of Madurai-based jewellery manufacturing and retailing firm Thangamayil Jewellery. The stock has gained almost 50% over the past one month. The buzz is that these buyers are betting on the company’s expansion plans. Brokers tracking the stock say that the company plans to open overseas branches to cater to the needs of ethnic population. This apart, it is also looking at a franchise model in Tamil Nadu. The expansion will be funded by internal accruals. Thangamayil shares closed at Rs 139 on Wednesday, up about 8% from the previous close, supported by heavy volumes. 

HCL Tech tanks 7 per cent on promoters shares sale report

 IT services provider HCL Technologies tanked 7 per cent on BSE in morning trade on Thursday amid a report that one of its promoters is likely to offload nearly 1.5 per cent stake in the open market.

Shares of HCL Technologies plunged 7 per cent to a low of Rs 347 a piece on the Bombay Stock Exchange (BSE). The scrip nosedived to Rs 353, down 5.28 per cent, on the National Stock Exchange.

According to the media report, promoter group firm HCL Corporation is eyeing to sell about 1 crore shares representing 1.5 per cent stake in HCL Tech, for an aggregate amount of Rs 360 crore.

As per the March quarter shareholding pattern available on BSE, HCL Corporation held 50.27 per cent stake in HCL Technologies.

Moser Baer to invest Rs 625 cr in solar energy instruments

Moser Baer PV, a subsidiary of Moser Baer India,  said it would invest maximum of $125 million (about Rs 625 crore) for manufacturing solar photovoltaic cells this current fiscal year.


Solar photovoltaic (PV) cells convert solar radiation into direct current electricity.
"We would be investing about 100-125 million in the current financial year (2010-11)," Dr Rajiv Arya, CEO Moser Baer photovoltaic business told reporters here.

On its listing plans, Arya said a team in the company was working on it but it was difficult to say when it was likely to happen.


Moser Baer PV that has manufacturing facilities in Greater Noida (UP), Chennai (Tamil Nadu) and Andhra Pradesh, says it will be reviving some of its expansion plans that it had previously postponed.


"We had put the expansion of our Chennai and AP plants on hold due to economic downturn but now we are reviving them," he said.


The company currently manufactures 90 Mw Polycrystaline PV cells and 50 Mw thin-film cells.

Anil Ambani likely to hive off DTH, IPTV biz into new entity

After placing its film exhibition and processing business Reliance Media Works and FM radio and outdoor advertising business Reliance Media World under separate listed entities, Anil Ambani’s Reliance Anil Dhirubhai Ambani Group (ADAG) may soon hive off its DTH and IPTV under a new entity—Reliance Digital Works (RDW).

Currently, the group operates its DTH business under the brand name Reliance Big TV, which is a subsidiary of Reliance Communications. RDW, that has existed for some time now, is expected to initiate the process of demerger from RComm soon. RDW may also become the group’s launch vehicle in the cable distribution business, industry sources said.

However, it is not clear whether the group’s foray into cable distribution will be a part of RDW or its subsidiary. Reliance ADAG has been looking for a substantial chunk of cable subscribers to foray into the business of cable distribution which is currently pegged at over Rs 3,500 crore.

While both Reliance Media Works and Reliance Media World are listed entities on the Bombay Stock Exchange, the group has been looking for capital infusion in its growing DTH business–Reliance Big TV. “In near future, the company may look at listing RDW as well,” a source said.

According to investment banking executives, RDW may help the ADA Group unlock the right value for its existing direct-to-home (DTH) and IPTV business. “If any entity gets hold of DTH, cable and IPTV business under one roof, the signals points to the direction of attracting investments,” an investment banker said. “Moreover, the DTH business requires big cash even more now as there are six players competing for the business. Unless the companies are clearly demarcated, foreign investors are not interested,” a senior executive a leading brokerage firm said.

While the foreign investment limits for the IPTV sector are kept at 74%, the government is expected to announce an increase in the foreign investment limits for the DTH sector as well–from current 49% to 74%. A similar move may be recommended by the sector regulator for the cable business, Trai insiders said.

“If the norms on foreign investments are at par in DTH, IPTV and the cable business, it will give a big levy to any firm that houses all these services under one company,” a senior executive of an existing cable company…

Hindalco may bid for Rio Tinto Alcan unit

Aditya Birla Group is evaluating the possibility of bidding for the rolled products division of Rio Tinto Alcan to boost sales in the United States and Europe, a financial daily reported today.

North American-based Novelis Inc, a unit of aluminium maker Hindalco Industries that is controlled by the Indian group, could put in a bid, the newspaper said, citing people familiar with the development.

It said the group was looking at various options for the deal including owning less than 100 per cent of the rolled products division of Rio Tinto Alcan, a unit of the global mining giant Rio Tinto.

Novelis is a Canadian corporation formed in January 2005 as a spin-off from Alcan Inc. In 2007, Novelis was acquired by Hindalco Industries. It is the world’s leading aluminium rolled products producer based on shipment volume.

It produces about 19 per cent of the world’s flat-rolled aluminium products and is the number one producer in Europe, South America and Asia, and the second-largest in North America, according to information on Hindalco’s website. Officials at Hindalco and Rio Tinto could not immediately be reached by Reuters for comment.

Reliance Annual Report FY10 Analysis

Commissioning of mega projects leads to doubling of balance sheet size in three years: RIL’s balance sheet size has doubled in three years, led by its investments in KG-D6 and the RPL merger. Its gross block has more than doubled in the last two years, led by commissioning of the KG-D6 project and the merger of RPL. Capitalized cost of KG-D6 is ~Rs390b while that of RPL is ~Rs330b.

RoE depressed due to higher DD&A and increased tax rate: RIL’s RoE for FY10 was depressed at 13.4% v/s an average of 20% in the last three years, led by higher DD&A charge, reduction in interest capitalized, and higher tax rate (21% in FY10 v/s an average of 16% in last three years).

Average interest cost down 390bp to 4.4%: Gross interest cost for FY10 was 4.4% v/s 8.3% in FY09. As 85% of RIL's total debt is forex-denominated, its interest cost is partly a reflection of LIBOR rate, which declined from 2.9% to 1.3%. Despite 15% reduction in gross debt, net interest cost increased 14% to Rs20b, led by lower interest capitalization (33% in FY10 v/s 66% in FY09).

1P reserves remain almost flat over the last four years: Though RIL has reported large number of discoveries in the last few years, its 1P (only reports 1P) reserve numbers have not increased significantly. Total reserves remained flat in FY10 at 1.5bboe. We expect RIL to upgrade its reserve numbers once the appraisal of the pending blocks is completed and approved by DGH (Director General of Hydrocarbons).

E&P has highest share in capex and depreciation: KG-D6 production start has lead to significant increase in the depletion charge for RIL, resulting in highest share in the overall company depreciation. Also, in terms of capex share, E&P capex was highest in FY10 at Rs118b as against total capex of Rs219b.

Key things to watch: We believe investors should focus on: (1) ramp-up of KGD6 volumes; (2) clarity on 7-year income tax holiday for KG-D6 gas (we model tax holiday); (3) margin trend in refining and petchem and (4) any announcements in terms of new projects, acquisitions, discoveries. (We estimate US$8b of FCF over next 2 years).

Valuation and view: We value RIL on SOTP basis to arrive at a price target of Rs1,133 (incl E&P upside potential of Rs205/share). Adjusted for treasury shares, RIL trades at 11.7x FY12E EPS of Rs87.9. Maintain Buy.