Company Analysis - Finolex Cables

Disclaimer: This report is prepared purely for academic purposes with data taken from secondary sources like company annual reports, company website, credit reports, research reports, screener.com etc.

This report intends to:

1. Analyze the various financial metrics of the company

2. Study the industry that the company operates in and analyze whether the company has any distinctive competitive advantages

3. Collate information from various Annual Reports, Investor Presentation Reports, Conference Call Transcripts and Credit Reports to understand the company strategy

This report is NOT:

1. An analyst report with future projections or target prices

2. A recommendation on the stock to “Buy” or “Not Buy” – since the company is listed

The contents of this document are personal opinions of the author based on the analysis done with the available information. Reader’s discretion is mandated when making any investment decision based on this information.

Introduction

Finolex Cables, established in 1958, is a leading manufacturer of electrical and communication cables. The company has also diversified into fast-moving electrical goods (FMEG) segment.

In this analysis, we shall look into the industry the company operates in, the financial metrics of the past, the operational efficiency and the company strategy.

Let us try to understand the business of Finolex Cables and the industry it operates in.

The Company – A Brief

Finolex Cables, as per the Annual Report 2019-20, is India’s largest and leading manufacturer of electrical and telecommunication cables. They have also diversified into fast-moving electrical goods (FMEG) segment and aims to be a complete electrical products company.

History of Finolex Cables

• In July 1945, two young brothers P.P. Chhabria and K.P. Chhabria came to Pune from Karachi in search of livelihood and within six months set up a small shop selling electrical cables.

• The retail business became quite successful. A sizeable order in the mid 1950's from the Defence Department for wire harnesses for trucks and tanks bolstered their confidence and they decided to manufacture Cables, themselves.

• Starting as a small-scale industrial unit in 1956, they manufactured PVC insulated cables for the automobile industry. Finolex brand was born from "Fine" & "Flexibles" and "O" with an electric arc across it - signifying the electrical cable business the company was in.

• Their relentless search for growth and doughty perseverance saw them through some difficult times and in 1972 the enterprise turned into a limited company.

• Since then, there has been no looking back and following a public offering in July 1983, Finolex Cables Limited embarked on a continuous process of expansion and modernisation which enabled it to become the most diversified & largest cable manufacturer in the country.

(Source: https://finolex.com/history/)

The company gives due importance to innovation in its field and has many firsts to its credit as mentioned in the Annual Report 2019-20:

Company Products and Operations

The company has five manufacturing sites at different locations in the country. Each plant caters or focuses upon a selected set of products. The details of these plants, their locations and the product focus as mentioned in Annual Report 2019-20 are as:

The Products

Finolex Cables provides the following range of products:

(Source: Annual Report 2019-20)

The company has a network of 5000+ distributors across the country for bringing out its products to its customers. The communication cables is largely a B2B business, while the electrical cables are sold to channel partners and institutional clients.

The company is also implementing a separate network for bringing the electrical products within the easy reach of customers.

Separate Network for electrical products

“Besides leveraging our wires and cables distribution network for our consumer-focussed range, we have also set up a separate distribution network to bring these products within the easy reach of consumers. We have adopted a two-tier distribution platform wherein distributors have clearly defined territories to reach out to retailers. Our aim is to partner with 500 distributors each covering around 300 retailers, to take our total retailer coverage to 1,50,000 touchpoints.”

(Source: Annual Report 2019-20)

The revenue break up for Finolex Cables from its Annual Report 2019-20 is:

An Analysis of the Past

Sales and Operating Profit

Let’s explore the growth in Sales and how the company has fared in maintaining the operating profit for the past ten years.

The sales of Finolex Cables are growing at a slow pace of 3.9% year on year for the past 10 years. From Rs 2036 Crores in 2011, the sales have grown to Rs 2877 Crores in 2020. However, the operating profit has grown from Rs 171Crores in 2011 to Rs 370 Crores in 2020 at an year on year growth of 8.9%. We need to further analyse to understand the reasons behind the faster growth shown in operating profit.

The operating profit margin was 8% in 2011. It increased steadily to 11% in 2014 and 15% in 2017. The operating profit margin stayed at 15% for the years 2017, 2018 and 2019; and in 2020 in reduced to 13%. A comparison of operating profit margin of Finolex Cables with its competitors Poly Cab India and KEI Industries shows that Finolex has been able to keep on par or slightly higher operating margin than its peers for the past five years. The below graph depicts the same.

Further analysis is necessary to understand whether the increase in the operating profit margins in the recent years are sustainable or not.

Net profit

(Source of financials: screener.com)

Finolex Cables has been able to grow its Net Profit from Rs 87 Crores in 2011 to Rs 402 Crore in 2020 at a CAGR of 18.6%. This has been an impressive growth of profits year on year. There have been two years (2015 and 2019) when profits declined compared to the previous year, in the past ten years.

The net profit margin increased from 4% in 2011 to 14% in 2020. Net Profit margin was in single digits from 2011 to 2015. Thereafter, in 2016 in increased to 11% and further increased to 13% in 2018. The net profit margin declined to 11% in 2019 and then incresaed to 14% in 2020.

The company’s ability to maintain a good operating profit shows its ability to pass on the increase in the cost of raw materials to its customers. The company has maintained a low debt, which futher helps to keep its net profit margins also healthy, as can be seen in the above graph.

Interest Coverage

The interest coverage ratio indicates whether company’s current earnings are sufficient to cover the interest commitments. The higher the ratio, greater is the ability of the firm to meet its debt obligations The ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by the company's interest expenses for the same period. A higher ratio means that the company would not be overburdened with debt issues during low business cycles or tough economic circumstances like the recent Covid-19 uncertainty.

With this understanding, let us check the debt and interest coverage of Finolex Cables:

(Source of financials: screener.com)

Throughout the years from 2011 to 2020, Finolex Cables has been able to maintain a high interest coverage ratio, which indicates that, its debt burden was low compared to its earnings. This also means that the capacity expansions that had taken place could have been financed from internal accruals.

As seen from the liability side of balance sheet, over the years, the long term borrowings has been on a declining trend for the company from 2009 to 2020. The years from 2017 till 2020 shows negligible long term borrowings. The low debt levels shall help the company to be resilient to economic shocks.

Debt to Equity Ratio is a common metric used to see the extent to which a company is leveraged.

Finolex Cables has always had a low Debt to Equity (D/E) ratio. Moreover, the company has successfully bought down its D/E from 0.36 in 2011 to 0 in 2017. Thereafter from 2017 onwards till 2020 D/E of the company was zero.

Operational Performance

Let us look at the split of expenses in the company.

(Source of financials: screener.com)

Raw material cost is the major component of the expenses. As a percentage of sales, this is around 75% and more or less consistent throughout the years. This again reflects the fact that Finolex Cables is able to pass the rise in cost of raw materials on to its customers.

(Source: Annual Report 2016-17)

Also, the raw material cost which was 81% of sales in 2011 was bought down to 72% of sales in 2020. This was the major reason for the improvement in operating profit margin over the years for the company.

Next, we can look at how efficiently the company is putting its assets to use and its inventory management.

Net Fixed Asset Turnover ratio compares sales from income statement and net fixed assets from balance sheet to measure the company’s ability to generate sales from its fixed asset investments comprising property, plant and equipment.

Inventory turnover indicates the rate at which a company sells and replaces its stock of goods during a particular period. Higher the inventory turn over the better, as it means there are more inventory turns happening in that period.

(Source of financials: screener.com)

Inventory turnover has decreased from 7.2 in 2011 to 4.9 in 2020. The diversification being done by the company might be requiring to hold more inventory, which might have caused the lowering of inventory turnover. This aspect needs to be monitored closely in future, so as to avoid any working capital crunch.

Net Fixed Asset Turnover (NFAT) however was 5.0 in 2011 and it had increased to 7.4 in 2020. The company has been doing phased expansions and it could be seen that these Capex done are also effectively being converted to sales. We can also infer to a certain extent that the capital allocation being done is proving effective for the company.

Cash Flows

(Source of financials: screener.com)

Finolex Cables in the last nine years, has generated a cumulative net profit of Rs 2319 Cr. The cumulative Cash from Operating Activity (CFO) over the same period has been Rs 1900 Cr. This means the company has not been able to convert all its profits into cash flow from operations, which would require further analysis. We have noticed that the business of Finolex Cables is working capital intensive in nature. We have already observed the rising inventory trend and hence the decreasing inventory turnover in the recent years, in our previous analysis. The held up of inventory in certain years as seen in the below image, could possibly be a reason for lower cashflow from operations.

(Source of financials: screener.com)

The noticeable change happened in 2017, wherein in inventory levels were much beyond the normal levels during the other years. In 2019, also the inventory accumulation was high, resulting in lower cashflow from operations.

(Source: Annual Report 2016-17)

The image above shows the continuous expansion and introduction of new products by the company during 2016-17. This could have also resulted in a situation wherein the inventory in hand for the company was also beyond the normal levels. Cash being stuck in receivables and high inventory is a concern and is the reason why the company is not able to convert the net profits into cash flow from operations. We need to closely monitor how the company fares here in the coming years.

We can also look into the receivable days of the company. Receivable days indicates the number of days customers are taking to pay a company for its sales.

Receivable days = 365/(Sales/average of trade receivables outstanding at the start of the year and at the end of the year)

The receivable days varied from 19 days to 25 days in the past nine years. The company seems to be able to keep the receivable days under check from the above data.

Also, we find that the company has been consistently investing in Capex. To increase the sales from Rs 2036Cr in 2011 to Rs 2877Cr in 2020 the company had spent a cumulative Capex of Rs 420 Cr. The cumulative cash flow from operations during this period was Rs 1900Crore. This means that the company was able to generate a Free Cash Flow of Rs 1480 Cr during the past ten years. The free cash flow was used to pay a total dividend of Rs 381Cr over the past ten years, to repay the debt and corresponding interest and also increase the company’s cash and investments by Rs 1394Cr, from Rs 266Cr in 2011 to Rs 1660Cr in 2020.

The company has been consistently spending on Capex over the years and we have seen from the NFAT turnover that these are helping in increasing sales too. Looking at an instance in 2014, when the company did a relatively high Capex of Rs 107 Cr, we find that a large part was being utilized to add or upgrade the plant and machinery in order to double the capacity at Roorkee plant.

(Source: Annual Report 2013-14)

Also, it is worth noting that along with the Capex being done, the company has given due importance to reducing its debt consistently as can be seen from the below images.

From the above three images we can see that the company had a long term borrowing of Rs 145Cr in March 2013. This could have been raised for the expansions and upgradations of plant and machinery we have discussed. Thereafter, year on year the company has bought down the debt to Rs 127 Cr in 2014; Rs 51Cr in 2015 and Rs 26Cr in 2016. We have already seen that the company is almost debt free now.

Return Ratios

Though many return ratios can be analysed, we shall focus on Return on Capital Employed (ROCE) and Return on Equity (ROE). ROCE can help to understand how well a company is generating profits from its capital as it is put to use. ROCE = EBIT/Capital Employed.

ROE is considered a measure of the profitability of a company with respect to stockholders’ equity. ROE = Net Income/Shareholders’ Equity.

(Source of financials: screener.com)

The Return on Equity was 13% in 2012 which increased to 20% in 2014. Thereafter RoE declined to 16% in 2020. This prompts us to check the PAT growth trend:

The PAT growth in recent years seems to have slowed down. Also last three years had shown a PAT growth of 8.4% compared to the nine year growth of 18.6%. This could be a reason for RoE falling. The DuPont Analysis which we shall do later would give us a further understanding on why the RoE has declined.

RoCE was 14% in 2012. The RoCE increased gradually and stabilised above 20% levels during the years 2014 to 2019. In 2020, the RoCE declined to 19% from 23% in 2019. We had also seen that the company has been doing continuous expansions and these expansions were helping in increasing the sales. This could be reason for the observed increasing trend in RoCE. Good capital allocation strategy by the company can be seen in the healthy RoCE over the years.

DuPont Analysis

DuPont analysis helps us to look further into detail of Return on equity. There are three major financial metrics that drive return on equity (ROE): operating efficiency, asset use efficiency and financial leverage.

This can be explained as:

(Source of financials: screener.com)

As can be seen from DuPont Analysis table, Net Profit Margin was 5% in 2012. It has increased to 14% in 2020. The increase in profit margin augurs well for the company also reflecting the fact that it has been able to keep its debt levels under control. So, it can been seen that the RoE was not able to make a proportionate increase due to the fall in Asset Turnover and Equity Multiplier.

The total asset turnover in 2012 was 1.7 in 2012. It fell to 0.96 in 2020. The increase in total assets was not able to produce the corresponding sales. However, we had seen that the Net Fixed Asset turnover was showing an increasing trend. This prompts us to check the Capex vs the depreciation done over the years.

(Source of financials: screener.com)

As can be seen, all the Capex done has been depreciated over the last ten years. This could be the reason NFAT is showing an increasing trend over the past ten years.

The equity multiplier has reduced from 1.52 in 2012 to 1.11 in 2020. This was also a factor in hindering the increase of RoE in proportion to that of net profit margin.

There was not dilution in equity over the years and share capital has remained the same.

(Source of financials: screener.com)

The Management

The company is headed at the helm by Mr. D.K Chhabria, Executive Chairman. The key managerial personnel of the company are:

(Source: Annual Report 2019-20)

The remuneration drawn by the Executive Directors/CFO for FY 2019-20 were as:

(Source: Annual Report 2019-20)

Executive Chairman draws a salary of Rs8.64 Crore which is around 2% of the Net Profit of the company.

The promoters hold 35.86% shares of the company. Prima facie, this looks inadequate to take on operational/strategic control of the company decisions. We can also look into the BSE website to see who the large public shareholders are.

(Source: https://www.bseindia.com/stock-share-price/finolex-cables-ltd/fincables/500144/shareholding-pattern/)

Here we find that members of the Chhabria family hold additional 4.29% (1.17%+3.12%) of shares. Also, Finolex Industries, a publically listed group company of the promoters, where Chhabria family exercises significant control, holds 14.53% of shares. We can assume that they would stand by the promoters of Finolex Cables with regard to the company board decisions. Hence, the promoters can expect a voting share of 54.68% (35.86+4.29+14.53) which would be enough to take on operational control of the company.

Other notable points of the company

The credit report by CRISIL dated March 03, 2021 mentions the following details (in italics), worth noting about Finolex Cables:

“Revenue is expected to grow by 5-7% over the medium term, driven by FCL’s established position in the electrical cables segment, its increasing distribution reach and digitisation of cable networks across the country. Growth will be further aided by traction in new segments such as fans, switchgears, and water heaters.”

CRISIL acknowledges Finolex’s established position in the electrical cables segment. It gives due importance to the strategy of the company in increasing its distribution reach, which would help significantly in the sales of its new products in FMEG segment.

“The company has maintained a healthy capital structure and strong debt protection metrics.”

We have already seen the approach of the company in reducing the debt. Also the company has nearly NIL long term borrowings as of now. This fact is mentioned in the CRISIL report.

“The rating also takes note of the ongoing dispute among the Chhabria family members (Mr Prakash Chhabria, executive chairman of Finolex Industries Ltd and Mr Deepak Chhabria, executive chairman of FCL) over management control of FCL, due to ownership issues in Orbit Electricals Pvt Ltd (Orbit, an investment company held by the promoters). The matter is sub-judice and has not impacted business operations of FCL so far.”

Matters like these involving family disputes over the control over the company can sometimes affect the operational performance and strategic directions of the company. How the matter proceeds out needs to be monitored into the future.

“The ratings continue to reflect FCL’s stable business risk profile, driven by its strong position in the electrical cables segment, established brand and integrated operations, and healthy financial risk profile, backed by healthy cash accrual.”

The brand recall of Finolex in its segment is mentioned by CRISIL in its report. Also, we have seen the debt management and healthy cash accrual by the company which is mentioned above.

“The strong distribution network will drive volume growth over the next two fiscals, and give the company an edge over its competitors in a highly fragmented market. Furthermore, backward integration with in-house availability of copper rods ensures timely supply of quality raw materials and an added benefit against small, unorganised players.”

CRISIL also mentions about the fragmented nature of the market in which the company operates. It mentions the strong distribution network and the focus on backward integration as major factors which would give Finolex an edge over its competitors.

“The communication cables segment will see reduced demand over the next fiscal, because of delayed investments by telecom, broadband, and direct-to-home companies. However, stable growth over the longer run will keep the long-term outlook healthy.”

CRISIL mentions that though there may be a fall in demand in short term for communication cables, the long-term outlook remains healthy.

Probable challenges for Finolex Cables

1. The primary raw material used by the company is Copper. This forms nearly 75% of the raw material cost. Any inability to pass on the price fluctuations to consumers can affect the company’s profitability.

2. Currently, ~80% of revenues comes from electrical cables which is consumed mainly by construction sector, automobile sector etc. Growth of these sectors are hence essential for the growth and better performance of Finolex Cables too. The growth of construction sector, automobile sector are directly linked to the overall economy making Finolex susceptible to the prevailing economic scenario in the country.

3. There are several unorganised players in the electrical cables segment. At times, they can also deter the pricing power of the organised players.

4. There are also other established players like Havells India Ltd and Polycab India Ltd in the same segment as that of Finolex. Hence, there is always the need to maintain optimum quality of products and also the possibility of intense competition which may affect the operating profitability of Finolex Cables in future.

5. It is only recently that Finolex Cables has forayed into the consumer durables segment with products like fans, switches, geysers etc. How effectively it can make its mark in this segment can only be known in the coming years.

Conclusion

Finolex Cables Limited is a leading manufacturer of electrical and telecommunication cables in India. In addition to manufacturing a wide variety of wires and cables, Finolex has also forayed into the manufacturing of Fast-Moving Electrical Goods (FMEG) and home appliances. Over the years, the Company has established itself as a preferred electrical solutions provider for retail and institutional markets in India and created a strong brand name.

The company has an established network of distributors and is continuously working on expanding this network. The company has always maintained a low debt level and has been prudent in building up its cash accruals. The company is currently in a position to internally fund its capex towards new capacities.

The company operates in a fragmented market and needs to be wary of intense competition from both organised and unorganised players, volatility in raw materials and any economic downturn.

Sales over the last ten years have grown year on year at a slow pace of 3.9%. The growth in the new segments, like consumer durables, the company is foraying into will be instrumental in deciding the future growth pace of the company.

About the Author

Dileepraj R is the CEO and Managing Partner of MintMelon Business Consulting LLP.