Thermax: Sell

The Thermax stock has moved up by over 40 per cent since our ‘hold’ recommendation in December 2012 at ₹595.

Thermax provides engineering solutions in the energy (75 per cent of revenues) and environment (25 per cent of revenues) space. Its business includes boilers and solutions in the areas of heating, cooling, chemicals, power generation, air pollution control and water treatment.

The major industries served include power, steel, cement, and oil and gas.

Amidst the economic slowdown, the company’s position as a proxy play on power sector reforms and its strong track record in projection execution have kept interest in the stock going. But existing investors can book profits at the current level of ₹838.

Though the stock has moved up based on high growth expectations, an improvement is yet to be seen in its performance. Thermax may not be able to come out of the woods for the next one or two quarters. Besides, valuations have expanded.

The stock now trades at 31 times its estimated earnings for 2014-15. This is in line with historical averages and doesn’t leave much scope for an upside. The stock has been on a losing streak since it touched its one-year high of ₹989 in early July.

This was partly due to lacklustre order inflows and a disappointing June quarter performance. FII holdings in the stock have pared by about 1.3 percentage points as at the end of June 2014 after being upped in every quarter last year.

The company’s net sales in the recent June quarter dropped 2 per cent year-on-year to ₹831 crore and operating profit fell 28 per cent to ₹58 crore.

Margins in both the energy and environment segments contracted by 4-5 percentage points compared to the year-ago period. Higher other income and lower tax outgo though, arrested the drop in net profits at 18 per cent to ₹41 crore.

Its order inflow was also nothing to brag about. During the quarter, the company booked orders of ₹662 crore, much lower than the ₹2,123 crore recorded a year ago.

Excluding the huge ₹1,350 crore order for high pressure boilers that pushed up the number for the April-June 2013 period, the order inflow in the recent June quarter is lower by 15 per cent.

The situation may not change in the next one or two quarters though there are some green shoots in the economy.

It will take a while before improved customer sentiments translate into higher capacity utilisation for various industries, which in turn will tap capital goods suppliers such as Thermax.

Thermax sees industries such as food processing, textiles and consumer durables among those to pick-up first, but it does not expect any substantial change in its fortunes in the next three to six months.

EPC (engineering, procurement and construction) orders from the steel and cement sectors, among the largest users of captive power, are expected to be further away, perhaps towards the end of 2014-15.

Barring the chemicals division, the environment segment is also plagued by slow order inflows and execution, with JNNURM-funded municipal water projects dwindling in the last few quarters. With only limited number of projects under finalisation currently and the company too becoming selective due to delayed disbursal of funds and cost overruns, this situation is not likely to reverse soon.

The air pollution control segment too, with its high dependence on steel and cement, will continue to see tough times in the near future.