Bullish on India: Is Thermax an underappreciated stock with long-term potential?

Muted growth in orders, low margins in some segments, potential for volatility in commodity prices and lack of visibility in refinery orders are some of the reasons why some analysts are bearish on the stock.

Pune-based Thermax has been an investor favourite thanks to its strong management, order inflow and potential for growth. The Indian multinational has offices in 29 countries and 14 manufacturing units—10 in India and four overseas. Thermax currently caters to more than 15 industries, from automobiles through textiles to power generation.

Now, with the next leg of economic growth underway, led by an upturn in the investment cycle, Thermax should be a resounding buy. But it is not among the top picks of analysts, although it has witnessed a steep rise in stock prices. Why? And should you consider Thermax a long-term play, given that there are few companies in the capital goods sector with a top-class governance track-record and proven management?

The negatives

Muted growth in orders, low margins in some segments, potential for volatility in commodity prices and the lack of visibility in refinery orders are some of the reasons why some analysts are bearish on the stock.

Thermax’s business is divided into four different segments: industrial products, industrial infrastructure, green solutions and chemicals. Industrial products (41 percent) and industrial infrastructure (45.2 percent) are its largest contributing segments followed by green solutions (5.5 percent) and chemicals (7.9 percent).

In Q1FY24, Thermax reported an increase in revenue across all segments. Revenue for the industrial products segment was up 26 percent Y-o-Y at Rs 836 crore. The industrial infrastructure segment saw 13 percent a Y-o-Y increase in revenue, at Rs 916 crore, while revenue for the Chemicals and Green Solutions segments grew 7 percent and surged 94 percent, respectively, to Rs 161 and Rs 113 crore, during the same period.

But, while Industrial products and chemicals have seen improvements in Q1FY24, the Industrial infrastructure segment faced challenges in previous quarters due to the low margins in the sector.

According to an ICICI report, the outlook for smaller orders remains reasonably strong, while the prospect for large orders is unlikely to improve in the near term. According to the management, there are some opportunities for orders worth less than Rs 500 crore. The report added that the Thermax management expects orders in the refinery segment to be muted in the near term; major orders are expected to start coming in from FY2027.

For Q1FY24, analysts at Geojit gave the stock a sell call based on concerns about the current ‘expensive’ valuation and a moderation in big-ticket orders. Based on its FY25 EPS of 60.4, at the current price of 2,783, the stock is valued at 35x. Geojit has a target price of Rs 2,113 on the stock. On the flip side, it sees potential for an increase in growth estimates for FY24 and FY25 to 15.3 percent and 11.5 percent, respectively, due to the strong order book pipeline and pick up in execution.

Analysts at BoB retained the hold call and rolled valuations forward to June 2025E arriving at a revised target price of Rs 2,600 (earlier Rs 2,400) based on 40x P/E multiple, in line with the stock’s 5-year average. Though order inflows were healthy with an improvement in outlook, analysts at BoB also believe that the weak infrastructure margins from legacy orders could remain a drag.

Analysts at ICICI Securities, on the other hand, downgraded their rating to an Add from a buy call. Their report also saw an increase in the target price by 5.2 percent to Rs 2,703 on the basis of a strong base order outlook. Given leadership in the company’s energy-efficiency offerings, the analysts assigned 40x FY25E earnings to the green solutions business. For the chemicals business, which has strong growth prospects but is at a nascent stage, analysts assigned a relatively lower multiple of 30x FY25E.

Notwithstanding volatility in its stock price, Thermax has seen a steady rise. On January 3, the stock was trading at 1,961.35, which has grown to Rs 2,749.7 at close on August 28, an increase of 40 percent. Part of that optimism stems from the big picture.

And the positives

One segment of the business that continues to be strong is industrial products due to the growing domestic economy, energy transition and water treatment infrastructure development in the country. Analysts at HDFC Securities say that the heating solution in particular is driving this segment.

In February 2023, Rs 10,222 crore was allocated in the Union Budget towards the renewable energy sector. This is 48 percent over 2023’s allocation of Rs 6,900.68 crore (budget estimate). “Green Growth” was announced as one of the priority sectors.

According to analysts at Prabhudas Lilladher, Thermax is well placed to gain from this increasing thrust on energy transition and decarbonisation initiatives thanks to its technical expertise, strong balance sheet and prudent working capital management

Similarly, HDFC Securities analysts say that in the coming fiscal years, Thermax will stand to benefit from investments in clean energy, sustainability, decarbonisation, normalisation of the international market and the impetus to clean air and water.

Another positive for the company is its strong management team and high promoter holding. As a company in the capital goods segment, through the years Thermax has also bagged large contracts from the government. After a challenging two years, the segment has been improving, especially in India, and some analysts believe that investing in capital goods stocks could be beneficial in the long run. A study by rating agency CRISIL estimates that the capital goods sector in India will grow by 16-18 percent in FY24.

Financials, a mixed bag

For Q1FY24, Thermax reported that its revenue had increased 18.5% to Rs 1,986.02 crore from Rs 1,675.02 crore in the same period a year earlier. Operating revenue also grew 16.8 percent to Rs 1,932.96 crore in the quarter compared to Rs 1,654.48 crore in the year-ago period. The company’s order inflow has grown 11 percent YoY in Q1FY24, beating Street estimates. During Q1FY24, Thermax received orders worth Rs 2,570 crore, up by 11 percent from the previous year and 14 percent QoQ.

Long-term optimism

While the short to medium view of most analysts is a mixed bag, some brokerages are of the view that in the long-run, there is an investment case for Thermax. In an analysis of Bloomberg data, out of 26 analysts, 9 had a buy recommendation, 10 said hold, while seven had a sell recommendation.

According to Avinash Kumar Pathak, analyst at LKP Securities, which has a buy call, Thermax, with over 14 manufacturing locations, is well placed to be the leader in clean water, clean air and clean energy solutions. Backed by infrastructure, PLI-linked capex, industrial capex and housing recovery, Pathak says in the report that the company should be able to sustain capex growth.

“The order inflow and pipeline remains strong and the order book at Rs 10,500 crore provides healthy visibility ahead. It continues to invest in new products to reap benefits ahead. Going forward, Thermax’s growth is expected to be driven by industrial growth and new capacity in various sectors, increasing demand for green solutions to address environmental concerns, and opportunities arising from urbanization and emerging applications,” wrote Pathak.

Analysts at Jefferies also hold a similar view. According to their report, margins are expected to rise, driven by revenue recovery and operating leverage. While acknowledging the possibility of India’s capex cycle not materialising, Jefferies has given Thermax a Buy call as they believe that the brand is well placed to be a leader for India in terms of clean water, clean air and clean energy solutions. “Directionally, as revenues mirror the macro trends, margin outlook should sustain/improve and see the stock re-rate,” the Jefferies report said.

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