Finolex Cables was one of those stocks that nobody wanted to touch with a barge pole. It got into serious trouble when it entered into exotic derivative contracts and lost a massive sum of Rs. 300 crore. It also suffered from volatility in copper prices which sent its’ margins plunging. The performance of the communication cable segment was also bleak owing to the slowdown in the economy.
In fact, the situation got so grim that LIC, the behemoth insurer, which never sells stocks even on the gravest provocation, got so fed up with Finolex Cables that it pared its massive holding of 7.21% in the company to a measly 1.85 as of date by dumping the stock. Even UTI, which had a massive holding in the stock, got out. LIC & UTI also had skirmishes with Finolex Cables’ management over the decision of the latter to sell the cables division to a subsidiary.
However, after that debacle, Finolex Cables got its act in order and began a slow but steady march towards recovery.
Today, LIC must be ruing its decision not to hold on tight to Finolex Cables because the stock has given scorching gains of 323% in 2 years and 186% in the last year.
Now the all-important question is whether there is anymore steam left in the stock for latecomers like us.
For this, we have to turn to the brilliant analysis by Bhargav Buddhadev & Deepesh Agarwal of Ambit Capital.
In a short but succinct research report (pdf), Bhargav & Deepesh have pointed out that Finolex is levered to a demand recovery in the B2B sector and that with the IIP growth, there is a growth in the fortunes of Finolex Cables. A great deal of empirical evidence is given in the report to support the hypothesis.
On the aspect of valuations, the authors have come out with all guns blazing by stating that the valuations are “Crying for a re-rating” and that the “steep discount to peers is unjustified”. It is emphasized that Finolex Cables is trading at 1.4x FY16 P/B despite its FY16 RoE of 23% and FY14-16 EPS CAGR of 31%. Compared with its peers, it is trading at a steep discount of 55% on FY16 EPS despite its higher FY14-16 EPS CAGR of 31% (vs peers’ 22%) and FY16 RoE of 23% (similar to peers), the authors say. It is also pointed out that compared with its cross-cycle average one-year forward P/B over FY04-09 (as FY09-13 is not comparable due to derivative loss), the stock is trading at a 36% discount despite its FY04-08 RoE of 9.6% and EPS CAGR of 32%.
Finolex Cables has other fans as well. Sharekhan has issued a report (pdf) in April 2014 pointing out that Finolex was making “a new beginning with the valuation capturing the true potential of its business and financials”. The improving financials, hefty cash generation, 17 percent earning CAGR (FY14-16E) and firm RoE will support valuation rerating, Sharekhan said.
The analysis of Ambit Capital and the others is very convincing indeed. The only downside is that copper is a major raw material for Finolex Cables and constitutes about 70% of the total raw material prices. Copper prices are known to be volatile and a steep surge can put a strain on the margins, at least temporarily. Also, as Ambit points out, Finolex’s prosperity is intimately linked to the growth of construction & industrial activity. A dip in the economy can send the stock into a tailspin.
Given that there are clear signs that the economy is picking up and that there is growth in the construction & industrial segment, Finolex Cables’ foreseeable future looks bright. However, given the recent steep run up in the price of the stock, it would be a good idea to keep a watchful eye and pick up the stock on dips.