In a major development, Prince Pipes & Fittings (PPF) has partially reversed a key related party transaction by receiving a major tranche (Rs261mn) of the advance payment (Rs400mn) made by the company to the promoter group Prince Marketing (PM). The transaction was related to purchase of a corporate office at Mumbai, which didn't materialise as the conveyance was not completed. With the steadily improving corporate governance, fast-improving balance sheet and progressing business model, we expect a material rerating of the stock going forward, which would aid narrowing of valuation discount with its immediate peers. At CMP, PPF trades at a 45% discount to Supreme Industries (SI) and 63% to Astral Poly Technik (ASTRA). Reiterate a compelling BUY at current levels.
- Valuation discount with peers to narrow with steadily improving governance. Despite transforming itself into a reputed/leading brand in the plastic piping industry over the last five years, the key rationale behind its steep valuation discount to its immediate peers (like SI and ASTRA) is the governance-related issue. Given the partial reversal of a key related party transaction and the company's bid to sharply improve its governance in the past, we reinstate a 25x P/E multiple while rolling forward our valuations to FY23 numbers. We thus retain our BUY rating with a revised target price of Rs450 (earlier: Rs400), valuing it at ~30%/45% discount to the multiples assigned to SI/ASTRA respectively. Key downside risks: sharper than expected fall in PVC prices and lower than expected demand.
- Steadily improving governance to lead to restoration of trust and confidence of its stakeholders. PPF has had its baggage of poor governance in the past namely: a) pledging of promoter shares; b) related party transactions; and c) promoter's exposure to the real estate sector. However, recently, the company in a bid to improve its governance, has taken various corrective measures. The current partial resolution of another key related party transaction is the testimony of its intent to become a strong governed company in line with immediate peers.
- Fast-improving business model. We expect PPF to be one of the major beneficiaries of the ongoing industry consolidation in PVC & CPVC pipes segment. This is largely driven by sustained progression in its business model over the last few years (considerable improvement in quality parameters, ramping up of brand building investments and brand monetisation, tightening of credit policy and investment in people and processes) and the recent steps (tie-up with US-based Lubrizol for sourcing of CPVC resin, entry into niche product segments like DWC pipes, plastic storage tanks, etc. and the upcoming Telangana plant, which would drive strong volume traction) initiated to take the brand to the next level.
- Sustained balance sheet improvement to drive higher RoCEs: Sharp curtailment in its receivables over the past few years has led to impressive FCF from operations in the past. Sustained strict working capital discipline and strong traction in profitability going forward would drive firm RoCEs of 20.7% by FY23E despite the large Telangana capex (PPF to remain a net cash-positive company in FY22E/FY23E).