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Expect margin tailwinds from Q4FY23

We recently interacted with the management of Finolex Industries (Finolex) and following are the key takeaways: 1) Demand from agriculture pipes is yet to pick-up in Q4FY23 post strong demand seen in Dec’22 (partly due to dealer restocking as PVC prices started to increase post a sharp decline). It is hopeful of better demand scenario in March as the busy season for agriculture has started (Feb-May) and PVC prices remain attractive post the steep correction of ~34% YTD. 2) Plumbing demand continues to remain steady as uptick in housing market sustains. 3) Profitability should normalise in pipe segment as PVC prices have stabilised in endDec’22, thus, resulting in no inventory losses. 4) In PVC resin segment, too, margins should improve QoQ as high cost inventory was mostly consumed in Q3FY23. We believe FNXP has near-term demand tailwinds as demand from agriculture segment (which accounts for ~60-65% of revenues) sees traction due to lower PVC prices and also margins are expected to normalise as PVC resin prices have stabilised. Maintain estimates and upgrade the stock from Add to BUY with an unchanged Mar’23 SoTP-based target price of Rs196.

* PVC pipe demand trend to remain healthy: The demand for pipes is expected to remain healthy as PVC prices have stabilised. Agri pipes demand is expected to pickup as PVC resin prices have corrected ~34% YTD and are now closer to pre-covid levels. With demand from agri sector being muted for the past 3 years this busy season (Feb-May) is likely to be robust aided by lower resin prices. Plumbing pipe sector demand has remained healthy as housing market continued to see an uptick. Management believes near-term agri pipe contribution may increase due to higher demand but with higher focus on non-agri segment, it expects this ratio to become equal over medium term. We have factored pipe volume CAGR of 16.1% over FY22- 25E.

* PVC pipe profitability to normalise from Q4FY23: With PVC prices stabilising in end-Q3 (inventory losses are not expected in Q4) and high cost inventory mostly being consumed in Q3FY23, profitability in PVC pipe business should normalise in Q4. The profitability in pipe segment should improve in the longer term with increased contribution from non-agri segment as it has better margins. We have modelled EBIT/kg in pipe segment to be ~Rs9/kg for FY24/25E. PVC resin profitability, too, is expected to improve QoQ as high cost inventory was consumed in Q3 and also PVCEDC spread is better.

* View and valuations: We continue to like Finolex for 1) its leadership in agri pipes, 2) strong brand presence, 3) increasing focus on growing higher-margin non-agri pipe business, and 4) its net debt-free balance sheet. Maintain estimates and upgrade the stock from Add to BUY with an unchanged Mar’24 SoTP-based target price of Rs196.

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