By Krishan Binani

India Ratings and Research (Ind-Ra) has affirmed Finolex Industries Limited’s (FIL) Long-Term Issuer Rating at ‘IND AA’. The Outlook is Stable. The instrument-wise rating actions are as follows:

Instrument Type

Date of Issuance

Coupon Rate

Maturity Date

Size of Issue (million)

Rating/Outlook

Rating Action

Fund-based working capital limit

-

-

-

INR1,500 (increased from INR1,000)

IND AA/Stable

Affirmed

Non-fund-based working capital limit

-

-

-

INR20,557.5 (increased from INR17,457.5)

IND A1+

Affirmed

KEY RATING DRIVERS

Sustained Strong Credit Metrics: FIL’s credit metrics remained resilient in FY20, despite deterioration because of lower EBITDA generation (FY20: INR4.5 billion, FY19: INR6.0 billion). Revenue declined 3% yoy to INR29,860 million in FY20 on account of a fall in petrochemical prices. The EBITDA interest coverage (EBITDA/interest expenses) was 37.6x in FY20 (FY19: 49.2x) while the company turned net debt positive at INR0.96 billion in FY20 (FY19: net cash of INR1.4 billion) due to an increase in inventory at end-March 2020, owing to COVID-19 led business disruptions, leading to a net leverage ratio (net debt/EBITDA) of 0.2x. EBITDA margin fell to 15% in FY20 (FY19: 19.5%), driven by lower margin in the polyvinyl chloride (PVC) segment partially, offset by increased margin in pipes & fittings (P&F) segment. Although FIL has restarted its operations which are currently running at 70%-90% capacity after a period of lockdown, the loss of sales in peak months of April and May 2020 is likely to impact profitability in FY21.

However, Ind-Ra expects FIL’s credit metrics to remain strong, aided by resilient agri-led demand, a potential rise in PVC margin, capex deferral and cost saving initiatives. Ind-Ra expects, FIL to report a strong rebound in FY22 profitability, based on recovery in demand and steady improvement in margins.

PVC Segment Profitability Likely to Recover in 2HFY21
: PVC segment EBIT margins declined to a five-year low to 11.9% in FY20 (FY19: 20.1%) on account of a 6% yoy decline in volumes owing to the disruptions in 4QFY20, lower product spreads, vinyl chloride monomer (VCM) shortage in 4QFY20 due to force majeure by a supplier, and potential inventory loss. FIL can produce PVC resin through both ethylene dichloride (EDC) and VCM routes, with EDC route being more profitable. The average spread between PVC-EDC fell to around USD559 per tonne in FY20 (FY19: USD597, FY18: USD723), while PVC-VCM spread narrowed to USD146 (FY19: USD211, FY18: USD211). Although the product spreads have recovered in 1QFY21, FIL is likely to reap benefit only post 2QFY21 due to the loss of volumes in April and May and presence of a high-cost raw material inventory.

Increase in P&F Segment Margin:
P&F segment EBIT margin expanded to 7.9% in FY20 (FY19: 7.1%. FY18: 5.1%), despite 3% yoy fall in volumes driven by extended monsoons/cyclones and the loss of volumes in March 2020.  FIL had resorted to price discounting to gain volume share in FY18, leading to supressed margins. Following the gradual opening of lockdown from end-April 2020, the company witnessed traction in agri-pipes, which constitutes 70% of the company’s sales. Ind-Ra believes any rural demand recovery would be faster than urban due to lesser incidences of COVID-19, supportive government measures, normal monsoons, and reverse migration from urban to rural.  The remaining 30% of the sales is linked to recovery in real estate construction, of which 30%-40% is generated in rural markets. 

Nonetheless, Ind-Ra believes the loss of peak demand in April and May would weigh on the overall profitability in FY21 despite an expectation of recovery in 2HFY21.

Liquidity Indicator - Adequate
: FIL has been reporting positive cash flow from operations (CFO) since FY12. In FY20, CFO plunged to INR1 billion (FY19: INR4.1 billion) on account of an increase in working capital outflow with the accumulation of inventory at year-end.  This coupled with significantly a higher dividend outflow of INR2.9 billion in FY20 (FY19: INR1.5 billion) caused free cash flow to turn negative to INR 2,469 million (INR1,546 million. Ind-Ra expects positive CFO and free cash flow over FY21-FY23 on the back of stabilisation of working capital cycle, improving profitability post FY22 and absence of any major debt-led capex amid a stable dividend payout ratio. FIL’s utilisation of its fund-based limits was negligible and its average non-fund-based working capital utilisation was 18% during the 12 months ended May 2020.

FIL’s net working capital cycle ranges between 80 days and 100 days, as it needs to stock inventory for five months. This is because the company sources its raw materials through a jetty, which remains closed during monsoons. The net working cycle has increased sharply to over 135 days in FY20 (FY19: 85 days) due to higher inventory levels. It primarily uses cash and carry model, except for non-agri P&F sales, which keeps its debtor days at low levels. The company’s liquidity is also supported by strong cash and cash equivalents of INR1.9 billion at end-March 2020. FIL does not have any term debt since FY16. FIL has not availed of the Reserve Bank of India-prescribed moratorium on its loan payments.

Focus on High-Margin Products:
FIL witnessed 6% yoy growth in chlorinated polyvinyl chloride (CPVC) P&F sales volume to 9,299 tonnes in FY20. It entered into a supply agreement in February 2017 with Lubrizol Corporation, the largest manufacturer of CPVC compound. CPVC commands higher margin than the current portfolio of products. FIL expects to utilise its 20,000tpa CPVC P&F capacity fully over the next two-to-three years. However, the company is likely to witness a subdued demand in this segment in FY21 due to its application in real estate industry. The company has also tripled its capacity of high-margin column pipes to 8,000 tonnes in recent years, with sales of 2,767 tonnes in FY20. Furthermore, FIL is aiming to increase the share of high-margin fittings volumes to 10% from 7% in the next few years in tandem with raising the non-agriculture share to 50% from 30%.  In FY20, the share of fittings rose to 8.1% of total P&F sales (FY19: 7.5%). As a result of these measures, Ind-Ra expects the margins to improve in the P&F segment.

Shift from PVC Resin to PVC Pipes
: FIL is shifting its focus to PVC pipes from PVC resin sales by increasing its captive PVC resin consumption. FIL’s share of captive consumption has steadily increased to 77% in FY20 (FY19: 74%). While the PVC resin capacity is constant, it has increased its pipe manufacturing capacity to 370,000 tonnes per annum (tpa) as of March 2019 (FY18: 330,000tpa, FY17: 290,000tpa). While the company has deferred all discretionary capital expenditure for the next six-to-nine months, FIL is likely to resume raising capacities by 10%-15% annually in the segment post normalisation of demand scenario post COVID-19. This will need annual capex of INR1,500 million (including maintenance capex) over the next few years, which will be mostly funded through internal accruals. With the rising proportion of P&F sales, the overall margin volatility is likely to reduce.

Leadership Position:
FIL has a leadership position, an established track record of over 25 years and an integrated business model in India’s PVC P&F and PVC resin industries. The company is the third-largest player in PVC and accounts for almost 20% market share by capacity. It is also one of the top players in plastic pipes with 9% revenue share.

Raw Material Volatility:
The company faces volatility in raw material prices as they are linked to international crude prices (major raw materials are all crude derivatives). Additionally, demand/supply balance in EDC and VCM markets, and its requirement to stock inventory for five months during monsoons exposes to the company to price risks. FIL is also exposed to forex fluctuation risk as it imports 85%-90% of its raw materials. However, it has an economic hedge as PVC’s selling price is linked to the dollar/rupee movement and to its international price.


RATING SENSITIVITIES

Positive: An increase in profitability, along with higher product and end-market diversification on a sustained basis while maintaining the credit metrics will be positive for the ratings.

Negative:
Deterioration in profitability and/or debt-led capex leading to net financial leverage increasing above 1.5x on a sustained basis could lead to a negative rating action.


COMPANY PROFILE

FIL was incorporated in 1981 as a PVC pipe manufacturer. It was backward integrated in 1994 and manufactures PVC resins at its plant in Ratnagiri. FIL had a total installed capacity of PVC P&F of 3,70,000tpa and PVC resins of 2,72,000tpa at end-FY19. 

FINANCIAL SUMMARY
 

Particulars

FY20

FY19

Revenue (INR billion)

29.9

30.9

EBITDA (INR billion)

4.5

6.0

EBITDA margin (%)

15.0

19.5

Total debt (INR billion)

2.8

0.9

Gross interest coverage (x)

37.6

49.2

Net leverage (x)

0.2

n.a.

Source: FIL, Ind-Ra


RATING HISTORY

Instrument Type

Current Rating/Outlook

Historical Rating/Outlook

Rating Type

Rated Limits (million)

Rating

9 May 2019

13 April 2018

30 March 2017

Issuer rating

Long-term

-

IND AA/Stable

IND AA/Stable

IND AA/Stable

IND AA/Stable

Fund-based limits

Long-term

INR1,500

IND AA/Stable

IND AA/Stable

IND AA/Stable

IND AA/Stable

Non-fund-based limits

Short-term

INR20,557.5

IND A1+

IND A1+

IND A1+

IND A1+


COMPLEXITY LEVEL OF INSTRUMENTS

For details on the complexity level of the instruments, please visit https://www.indiaratings.co.in/complexity-indicators.
 

SOLICITATION DISCLOSURES

Additional information is available at www.indiaratings.co.in. The ratings above were solicited by, or on behalf of, the issuer, and therefore, India Ratings has been compensated for the provision of the ratings. 

Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer.

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Applicable Criteria

Analyst Names

  • Primary Analyst

    Krishan Binani

    Director
    India Ratings and Research Pvt Ltd Wockhardt Towers, 4th Floor, West Wing, Bandra Kurla Complex, Bandra East,Mumbai - 400051
    +91 22 40356162

    Media Relation

    Ankur Dahiya

    Manager – Corporate Communication
    +91 22 40356121