Thermax’s (TMX) primary product portfolio comprising Boilers, Heaters, Chillers and Captive Power Plants is heavily dependent on energy intensive manufacturing industries. Its core business industries of cement, non-ferrous and refineries place orders during the late cycle. However, most of these industries continue to operate at sub-optimal utilisation levels, which in our view will keep capex growth weak well into FY17e.
New emission norm led capex could lead to an earlier-than-expected business revival
The government has announced that it will revise emission norms to meet Euro VI equivalent standards with a view to reducing pollution levels. Additionally, power plants will have to cut SOx and NOx emissions, while refineries will have to install hydrogen treatment units in order to upgrade to the new norms. Both these initiatives together will entail a capex of c$12-15 bn and provide a healthy opportunity for TMX. We believe TMX should be able to capitalise on this opportunity by using its technology tie-ups with Babcock and Wilcox. We expect this level of capex could contribute up to 10-15% of TMX’s revenues during FY18e-20e.
Cut earnings by 20-26% to factor in near-term business weakness
We have cut our near-term earnings forecasts to reflect the current weak order book, while anticipating emission revision led capex to benefit TMX from FY18e/FY19e.
New business outlook likely to limit the valuation downside
The TMX share price is down 14% y-t-d, largely due to a weak recovery in industrial capex. However, we believe the new emission-led capex opportunity provides a tangible benefit over the long-term as well as acting as a counter to the weak manufacturing capex business. While it might not add to earnings growth before FY18e, we expect it to restrict the valuation downslide.
Retain Hold with a lower TP of R829 from R975 (down 15%)
We continue to derive our TP for TMX using an unchanged target PE multiple of 27x 1-year forward PE (x) to reflect our sharp earnings recovery outlook, perceived good quality of management and a low earnings base. The stock is currently trading at 25.4x FY17 PE (x) implying a modest upside. With an upside of 6.7%, we maintain our Hold rating.
A small ray of hope
Order book weakness is likely to hurt near- to medium-term earnings
The TMX share price has fallen by 14% y-t-d, which is largely in line with its peers. The sector weakness has mainly been driven by the weak outlook for industrial capex as sectors like Steel, Cement and Power continue to work at sub-optimal capacity utilisation.
Order book decline likely to hurt near-term growth outlook
Although TMX’s new orders trend has stabilised at cR7-9 bn, it is still very low to help sustain sales growth. TMX’s order book is also down 24% y-o-y, which is likely to restrict any meaningful execution in our view. Moreover, we believe the lack of large ticket orders especially from Cement, Steel and Power will restrict a quick execution scale-up. While sectors like Pharma, Food Processing, Paper, etc can provide reasonably steady orders, they are unlikely to drive overall portfolio growth, in our view. However, we expect TMX’s consistent addition of new products will lead to better revenue mix and its focus on cost management should continue to impact margins positively.
Emission norms led capex boost provides optimism on a business recovery
The Government has recently updated emission norms for thermal power plants, which could lead to investments of c$10-12 bn in the Desulphurisation process. Similarly, the Government’s decision to upgrade to Euro VI norms to reduce vehicle-related pollution in large cities will result in oil refiners upgrading plants to contain SOx and NOx with potential capex investments of $3-4 bn. We believe Thermax, through its joint venture with Babcock and Wilcox, is in a strong position to take advantage of this upcoming business opportunity.
Power plants: The government has announced its initiative to upgrade/amend emission control norms for power plants, depending on the year of commissioning (i.e. before FY03, FY03-FY16, and after FY16). These steps will require power plants to consume less water, and lower emissions for particulate matter, Sulphur dioxide (SO2) and Oxides of Nitrogen (NO) and mercury.
Refinery capex: The revised target to meet Euro VI standards by April 2020 will require Oil refiners to spend $3-4 bn over the next few years. Oil refiners will have to add facilities like Isomerisation, Diesel Hydrotreator and Hydrogen Treatment Units (HTU) to meet the revised emission standards. We expect IOC, HPCL and BPCL will have already earmarked funds for the necessary upgrades.
TMX is well placed to take advantage of this opportunity
TMX’s JV with Babcock and Wilcox should make it one of the frontrunners for this emission norms revision-led capex opportunity as Babcock and Wilcox is one of the leading players in the SCR market. TMX has already absorbed the SOx technology from its partner and we believe it is also in a strong position to tap into this market. Whilst BHEL is yet to partner with its technology partner (Alstom) we expect it will reach a JV agreement in time to benefit from the anticipated new orders.
Cut earnings forecasts by 20-26% over FY16-18
We have cut our earnings forecast to factor in the current weak business environment given the 9M FY16 order book is down 25% y-o-y and industrial capex continues to be affected by industry-wide sub-optimal capacity utilisation. We expect this will hurt near-term new orders growth and is now well reflected in our revised earnings forecasts. Our earnings forecasts are still 10-21% above consensus for FY17e/FY18e; despite that we believe sales to be largely in line with expectations.
Retain Hold rating with a revised TP of R829 (down 15%)
We perceive TMX as one of the key players in its key product categories servicing the BHC and CPP segment. We find the ability of TMX’s management to target new business segments to mitigate the current slowdown compelling. While this is yet to be reflected in an improvement in earnings, we expect the company to be able to recover faster than its peers once the business recovery sets in. Our forecasts also factor a strong 22% EPS CAGR for FY16e-FY18e and our better-than-consensus forecasts lead us to maintain our Hold rating which is currently anti-consensus . We continue to value TMX at 2 SD above its historical mean PE of 17.9x, as we believe this reflects the anticipated earnings recovery as well the low earnings base. We have, however, carried forward our valuation base from December 2016 to March 2017. We derive our target price using an unchanged target PE multiple of 27.1x our March 2017 EPS of R30.57.