Why Nalanda and SBI MF are on opposite sides of the trade in Thermax

Thermax's order intake for FY24 was on the lower end, and the order book stood at only 4 percent over that of FY23.

Earlier this month, two funds known for their long-term commitment to high-quality stocks were on opposite sides of a deal.

SBI Mutual Fund bought a 1.15% stake in Thermax, acquiring around 13 lakh shares at an average price of Rs 5,100 each. Meanwhile, Singapore-based Nalanda India Equity Fund Limited sold a 1.26% stake, or about 15 lakh shares, at the same price.

Both funds are known for their long-term, high-quality investments, much like Warren Buffett. Nalanda Capital emphasizes its role as a permanent owner of top-tier businesses, which raises questions about its decision to sell.

Nalanda was the largest institutional stakeholder as of March 2024, with 6.86%, followed by Kotak Mutual Fund (6.37%) and SBI Mutual Fund (3.37%).

Also Read | Thermax to renew focus on power projects in FY25: CEO Ashish Bhandari

Why did Nalanda sell?

Considering Thermax's impressive run—its shares surged 68% this year alone—Nalanda's sale might be simply to trim its position a bit, say people familiar with the fund’s strategy. It could also be to deal with portfolio liquidity. The fund opens for redemption every June, and selling 15 lakh shares might be a strategic move to free up cash.

Yet, the truth is analysts are largely bearish on the stock. Although the time horizon over which Nalanda or, for that matter, SBI Mutual Fund, look at stocks is vastly different from the 12-month time frame over which analysts usually evaluate a stock, the steep appreciation in the stock price makes it ripe enough to trim.

Based on data available with Bloomberg, five analysts have a buy on the stock, 10 have a hold, and nine have a sell call. That’s predominantly bearish, with only 20% buy calls, as hold recommendations are largely assumed to be negative calls. Parth Shah, Research Analyst at StoxBox, notes, “Expensive valuations, slower topline growth, incremental capex requirements, and a recent slowdown in order intake are definite triggers for selling.”

At the current price of Rs 5,199, the stock commands a market cap of Rs 61,950 crore, trading at over 100 times earnings. While the company's sales and profits have grown at 25% and 34%, respectively, over the past three years, the stock price has outpaced these metrics with a 51% CAGR.

It has also outperformed other stocks in the capital goods sector. Thermax’s shares have risen 135% over the past year, compared to a 84% rise in the BSE Capital Goods index. Amit Goel, Co-Founder & Chief Global Strategist at Pace 360, said, “We don’t see much upside due to its high valuation, as its multiples are far above what earnings growth would justify. It's trading significantly above the sector average of 57x also.”

Uninspiring performance

Indeed, Thermax’s performance was a tad disappointing for the past fiscal. Thermax offers solutions to energy, environment, and chemical sectors, with energy contributing a bulk of its revenue of over 70%. It reported a growth of 15% YoY in FY24, which was only about half of the growth seen in the previous two fiscals. Order intake for the year was on the lower end, and the order book stood at only 4% over that of FY23. Analysts have mixed views on how growth will pan out this year.

In the March earnings call, CEO Ashish Bhandari highlighted the reasons for the slowing order intake but also said they see good traction over the next couple of quarters with a pipeline stronger than last year. Thermax's international order pipeline is strengthening, particularly in water desalination and treatment. The chemical segment is also expanding. But overall, analysts at Nuvama point out the timeline of large-ticker orders, input cost volatility, and competition intensity as factors that will impact profitability.

Beyond the quarters

The case for Thermax becomes strong only when you look beyond the immediate term. It’s one of the very few home-grown engineering companies that is well poised to meet energy transition demands. There is a tailwind in the sector, and government policies and capex on green technologies like biofuels will boost Thermax’s clean energy portfolio. Then again, Parth Shah added, “Green hydrogen is still nascent in India, but with significant growth potential, we expect Thermax to invest further following future policy decisions.”

More importantly, in an industry rife with governance issues, Thermax’s management stands out, which makes a certain premium over peers justifiable. Whether high multiples align with future growth elicits different answers from different fund managers. But the management is largely perceived as efficient in capital allocation and has consistently delivered reasonable return ratios.

As for the different strategies of Nalanda and SBI Mutual Fund, this seems to reflect a dichotomy of sorts: the former trimming to meet redemptions, and the latter lapping it up to deal with plentiful flows.

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