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Finolex Cables: Managing operations well - Outside View by Luke Verghese
 
 
Finolex Cables: Managing operations well

Operating in a highly competitive but simultaneously expanding sphere of power and telecommunication cables, the company is now forging ahead through the creation of additional capacities via in-house and outhouse facilities, and with the help of cash generated from operations, while keeping the borrowings under control.

A long inning and still going strong

The company states that it has been around since 1958 when the two founder Chhabria brothers sowed the seeds of its future. That would imply it has been operating for 55 years. But the copy also states that the entity has been around for 58 years. The latest annual report however is the 45th such report. But this is only a minor matter. Finolex Cables has come quite some distance however from its initial days under the hot sun-from one manufacturing location in Pimpri to 10 locations today and spread across three states.

By all accounts the company has done well for itself top-line wise over the last decade from the brief financials which have been made available. The gross revenues have rocketed from Rs 5.68 bn in the base year 2003-04 to Rs 24.47 bn in the latest year. But the pattern in the profit before tax has not been anywhere near as fortunate. This aspect has unfortunately chosen the wavering and erratic current supply path so to speak. In 2008-09 the company even managed to report a pre-tax loss of Rs 301 m. But the pre-tax profit of Rs 1.7 bn in the latest year is also the highest in the last decade. The wavering profits would imply stiff competition in the segment that it operates in, and in its inability to mark up prices to counter higher input costs and that of wages. The fact is that input cost of materials hovers at around 75-77% of net sales. Wages rose 21.7% against a 10% increase in sales net of excise.

More productivity from gross block

Significantly, the gross block has risen only marginally from Rs 4.77 bn in the base year to Rs 9.77 bn in the latest year-implying its ability to get more than double the revenue bang for the gross block buck from a relatively low ratio of 1.12:1 in the base year. The company however generated more than sufficient cash from operations in the last two years to fund its fixed asset expansion. The net debt too has been well contained rising from Rs 1.88 bn in the base year to a high of Rs 2.9 bn in 2007-08, but it was down to the same level as that of the base year in the latest year end. The paid up share capital of which the promoters hold 36% has remained unchanged all through at Rs 306 m. ( A group company Finolex Industries holds 14.5% of the outstanding voting capital while Orbit Electricals Private Ltd holds a further 30.6% of the capital. If Orbit is a group company in any sense of the term, then the total promoter holding would amount to 45.1% and not 36%). But let that be. In the last five years the company has also pussyfooted on its dividend payment policy by limiting the dividend outflow to around 14% of the post tax profit.

The main body of the revenues

The main body of revenues as the name plate infers accrues from cables --- electrical and communication cables. They have several customer sectors-automotive, agriculture and construction in the electrical segment and coaxial and optic fibre cables in the communications segment. The company generated sales net of excise of Rs 23.89 bn. The vast bulk of the revenues -87% or Rs 20.86 bn -- accrues from the sale of Electrical cables. This is followed in second place by Communication cables with a share of 8% or Rs 2 bn. Copper rods, which are the raw material for the manufacture of copper based electrical and communication cables, was also separately retailed in small quantities and brought in a marginal share of 3.5% or Rs 836 m (its share was much higher at 10% in the preceding year) while 'others' brought in a pittance of Rs 206 m. Then there are minor picking from sales of finished goods and from scrap sales. The 'others' probably refers to the new lamp models including LED based lighting systems meant for home and commercial spaces that it introduced. It also plans to enter into the space of switchgears of various shapes and sizes. But both these segments are also littered with competition. The company is also investing Rs 500 m in additional cable making equipment at the optical fibre facility at Goa to take advantage of the announcement by the Government to create a national optic fibre network. There is also the Rs 1 bn concurrent expansion of its plant facilities at Roorkee expected to be complete in 2013. It is not quite clear what this expansion pertains to. The company has in the last two years added Rs 747 m to its tangible gross block while the capital-work-in-progress at year end amounted to Rs 357 m.

The company has deigned to provide the division wise pickings of its product lines. The electrical cable business earned a segmental gross profit margin of 12.2%, while the communication cable business earned a slightly higher segmental gross profit margin of 13.3%. In reality the second largest product segment is copper rods with inter-segmental sales of Rs 6.2 bn and revenue earning sales of Rs 836 m. This segment earned a marginal profit of Rs 41 m. The 'others' segment has yet to turn the corner, registering a marginal loss.

Control over debt accumulation

Though the debt at year end was marginally higher at Rs 1.8 bn against Rs 1.7 bn previously, the company has managed the interest payout on the debt very judiciously. (The higher level of borrowings was pumped into current investments). The interest cost of Rs 125 m against Rs 169 m previously implies that the percentage rate of interest is below 7% for the latest year on a rough back of the envelope calculation. The total finance charges of Rs 261 m for the preceding year includes Rs 82 m in the form of exchange differences on borrowing costs as against Rs NIL in the latter year. This expense is not inclusive of the rap that the company took on its knuckles for Rs 230 m in exceptional revenue costs on account of 'losses incurred on derivative contracts' against a higher loss of Rs 364 m previously. How the company gets it all wrong repeatedly on this count is not explained adequately, or on what the company plans to do about it.

Group company investments

However, the company is also lucky that it has some other income to depend on for succour. Such income accounted for 12.5% of pre-tax profit against a sizeable 22% previously. The other income largely consists of dividend income from its long term investments, net gain on sale of investments and interest on bank deposits etc. The company had investments of the book value of Rs 2.1 bn in group companies and current investments of the value of Rs 1 bn at year end. The biggest investment chunk is in group company Finolex Industries Ltd -which in turn holds equity in Finolex Cables-at Rs 1.5 bn, at an acquisition cost of Rs 38 per share. (Finolex Cables is the only one that pays a dividend). Then there is the joint venture, Finolex Infrastructure Ltd, with an investment of Rs 480 m, a Rs 53 m investment in Finolex Infrastructure, and a Rs 10 m investment in Finolex Plasson Industries. There is also a very minor investment of Rs 0.5 m in a company called Corning Finolex Optical Fibre Pvt Ltd. This may morph into a major investment in the future and may involve additional capital subscription. There also appears to be an associate company going by the name of Finprop Advisory Services-but there is no clear evidence of any investment in this outfit. Significantly, none of the group company investments come in the bracket of 'subsidiaries'. The effect of this is that the shareholders of Finolex Cables have no access even to the limited financial statements that siblings have to post.

Thus, for better or worse, this is a cross that Finolex Cables has to bear-namely the group company investments currently having a book value of Rs 2.1 bn. For the present the company has minor infractions with some of the group affiliates in the form of sales of goods and services, purchase of raw materials and components, and the sale and purchase of fixed assets.

The capital investments that the company is making should hopefully lead to a sharp surge in revenues over the next few years as the expanded capacity of the electrical and communication cables units come on stream. It is not clear whether the capacity additions include that of production capacities in optical fibres or whether this is a wholly separate legal entity. It should also be benefiting from the introduction of LED based lighting systems and from the switchgear product segment. But, there appears to be some sort of an overlap here. There is the simultaneous coming on stream of its JV unit, Finolex J-Power Systems which is also into the manufacture of power cables and the optical fibre unit under yet another company, Corning Finolex Optic Fibres. Where exactly all this fits in is not very clear. But, hopefully, the management has got its game plan in order, and for the benefit of all shareholders.

The outlook

New capacities or not, the margins will continue to be under strain given the number of players in the power cable, and the lighting and switchgear industry. But the notable achievement is that the debt that it has contracted to secure the new assets in under control and this is a very moot factor. In the meantime the share price -- Rs 2 paid up per share - oscillated between a high of Rs 64.20 and a low of Rs 31.30 in the last financial year. That is a considerable depth in movement given the low profile of the company. The other plus point of the accounts and the notes to the accounts is in the transparency built into it.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

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