Some great cable stocks to look at

How would the world look without those amazing phone ring tones or the myriad images that flash across our computer screens by the minute? Well, it would very much be a world without cables.

But investors at least aren't really considering cables as very essential. At the bourses, well known names in the cable space have had mixed experiences. While Finolex Cables at Rs 91 is down by 10 per cent, others such as Sterlite Optical (Rs 246), KEI Industries (Rs 106) and Universal Cables (Rs 104) have outperformed the Sensex with returns ranging from 2 to 29 per cent since the beginning of the year.

"There is little doubt that cable scrips are quite undervalued at present," says Shreegopal Jajoo, research analyst, B&K Securities adding, "It appears that other than volatile copper prices, investors are also feeling a little leery about the management capabilities of some of the companies."

Whatever be the case, despite the sensitivity to raw material prices, a careful and selective perusal may yield some good investment picks.

More power to cable

Firstly, the sector as a whole operates in what is a benign macro environment. In the power arena, the government plans to add 66 GW of power generation in the eleventh five year plan, indicating a compounded annual growth rate of 9.3 per cent.

Moreover, the power grid plans to spend Rs 70,500 crore (Rs 705 billion) to add 60,000 ckt km of lines by 2012 as part of the APRDP scheme, started in 2001 to reduce transmission and distribution (T&D) losses by state electricity boards.

All these investments would provide a key impetus to the demand for cables. According to some estimates, 20 per cent of investment in the power distribution network goes towards cables. Moreover, other than the massive government focus on the power sector, there is the demand arising from the huge industrial investment too.

According to industry sources, all new projects will spend 3-4 per cent of total planned investment on power cables. The fibre optic cable segment too should benefit from the increasing reach of broadband and the rapid spread of telephony, both wired and wireless across the country.

Material losses

While the favourable demand condition remains a chief upside, what remains a chief risk, especially for the power and electrical cables segment, is the volatility in the prices of key raw materials viz copper and aluminium.

While copper prices at the London Metal Exchange increased by 40 per cent in 2006, they were marked by high volatility. Even this year while they have surged 29 per cent till May, the prices since then have collapsed from about $8194 to around $7200 currently.

Aluminium prices have also fluctuated in the range of $2400 to $2900. While a rise in copper prices hurts margins given that raw materials constitute 60-70 per cent of sales of major players, an unexpected fall does not immediately translate into better profitability since companies usually hold at least a 4-6 week inventory

The March quarter results of the cable companies reflected both the strong demand scenario as also the raw material pressures. For example, prominent players made out quite a happy picture on the topline front -- KEI (101 per cent), Finolex (38.14 per cent) and Sterlite (119 per cent).

At the same time, all of them faced an erosion in operating margins of anywhere between 465 - 610 basis points. And while metal analysts generally concur that copper prices could stabilise at around $7000 at least over the next quarter, they aren't so sure about aluminium prices.

So in such a scenario, what would be the best picks for investors? As regards valuations, cable companies like KEI, Finolex and Sterlite trade at around 9.4-12.7 times the estimated earnings, which seems reasonable.

That apart, "I would say that investors should look at companies that have a diversified product portfolio with presence in segments which enjoy greater pricing power," says an analyst from a domestic broking firm.

And it would be prudent to take a long term view with an eye on the fundamentals of the company. In this regard, there may be a few stocks which may make a good quality investment.

Connect with them

Finolex Cables:

Despite its tepid March quarter which severely affected sentiments, Finolex Cables has been one of the few players which has managed to increase its operating margins for FY07 by 130 basis points to 11.5 per cent.

The company seems to be benefiting from the increasing share of electrical cables, which at 16-17 per cent, have higher margins compared to communication cables.

The continued focus on the higher margin new generation cables like LAN, coaxial, VSAT and PE insulated cables whose contribution to total sales is expected to go up from 25 per cent of the communication segment at present to 35 per cent in the next two years, should also hold it in good stead.

"A main positive for Finolex cables however remains its premium status in the highly price competitive light duty cable segment," feels Vineet Agrawal, research analyst ULJK Securities.

And even here, with the government authorised standardisation and lower taxation of 4 per cent VAT in contrast to 12 per cent CST earlier has tilted the scale away from the informal sector and towards branded players like Finolex Cables. Overall, analysts expect Finolex Cables' earnings per share to grow at a CAGR of 30 per cent over the next two years.

Sterlite Optical:

Outside the power arena, analysts also see some bright spots in Sterlite Optical Technologies. While the company derives 34.6 per cent of its revenues from optical fibre and fiber optic cables at present, the recent revival in demand and the continuing focus to bring optical fibre closer to the subscriber could make this segment more significant for the company.

Speaking on the opportunities present, Anand Agarwal, chief executive officer and director, Sterlite Optical Technologies says, "While in the recent past, the optic fiber industry has been plagued with an oversupply situation, indications are ripe that strong demand growth would soon correct this mismatch."

For example, globally the annual demand in 2006 is estimated to have grown by 25 per cent to touch 90-100 million kms which is close to the pre-slowdown levels, according to an analyst tracking the segment.

And while Sterlite's well integrated supply chain and strong R&D back-up have already helped it garner a 43 per cent share in the domestic market, its focus on Europe in the international arena for its last mile products should stand it in good stead as major countries like Italy and France push aggressively towards last mile connectivity.

KEI Industries:

Major cable players are also focussing on higher voltage and high tension power cables to offset margin pressures and improve realisations. For example, realisations of 1.5-2 per cent on high tension cables (used for bulk power transmission in cities) remain higher than light duty/low tension cables.

And KEI Industries is already betting big on this segment. Its high tension cable capacity on stream since Q2 FY07 has already started yielding results especially on the export front. Last fiscal, the company bagged two large orders from the Middle-east -- a Rs 25 crore (Rs 250 million) order from FEWA, Dubai and another worth Rs 16 crore (Rs 160 million) for an aluminium project in Oman.

The company's export focus is however quite holistic. "Overall we expect our exports to touch Rs 200 crore (Rs 2 billion) in FY08 up from the current Rs 82-83 crore (Rs 820-830 million), " says Kishore Kunal, company secretary, KEI Industries.

This would imply that the contribution of exports to revenues would increase from 12 per cent currently to over 16.6 per cent of estimated FY08 earnings. The company's newly commissioned plant at Chaupanki to manufacture low tension and control cables would also help it in its drive for exports. Overall, analysts estimate KEI Industries' earnings to grow at a CAGR of 26 per cent over the next two years.

RPG Cables:

Other power and transmission cable makers are also hoping to gain from higher voltage segment. Finolex Cables is already to roll out its heavy duty 66 kv power cables from its Urse plant. Another company which is betting big on the voltage shift is RPG Cables.

As a senior official of the company puts it, "The proportion of extra high voltage and high voltage cables which is about 40 per cent currently should rise to about 50 per cent of total revenues in 2009."