Thermax MD & CEO, Ashish Bhandari, mentioned improving the business environment for Thermax during Sep-Nov. Thermax is trading at 26X 2-yr forward P/E. With 11-12% RoE in FY22/23E and growth uncertainty from the weak capex cycle, Macquarie finds Thermax expensive at current market price. They retain Underperform rating with unchanged target price of Rs 710.

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Key takeaways from management commentary are as follows:

Base business normalizing: Most of Thermax’s base business has normalized to levels seen a year ago. Customers are witnessing profitability improvement on revenue recovery and cost controls leading to optimism in FMCG, pharma, chemicals, F&B, cement, steel, textile and manufacturing industries. The customers are thus willing to undertake small-capex projects with 1-3 yr payback period, esp. in sustainability and environmental solutions.

FGD prospects may face a 6 month delay: The CEO highlighted that geopolitical issues and restrictions on imports from China have led to cost increases in FGD. Many projects are thus undergoing approval processes for the revised costs. The company thus expects a 6-month delay in order awards but remains optimistic of FGD prospects ‘sooner or later’.
Small-sized M&A not ruled out: Management said that ‘Clean Tech’ by default means ‘Hi-Tech’ and Thermax is thus willing to look at multiple options for technology access including partnerships, licensing arrangements or small sized M&A that would not stress the company’s balance sheet.

Order inflow risks skewed to the downside: While Sep-2020 witnessed a small 0.9% increase in steel production and 3.5% contraction in cement production as per the govt data, Oct-2020 saw an improvement in manufacturing PMI to 58.9. Sustainability of these indicators is important to monitor. For FY21/22E, we have already modelled order inflows of Rs 52 / 62 bn respectively on hopes of recovery. The ask rate is thus optimistic for the second half of FY21 and FY22 vs Thermax’s average quarterly order inflow run rate of Rs 12-13bn over the past five years. Any infra stimulus from the government will first benefit EPC companies (L&T, KEC International) and construction materials (cement, steel) before the trickle-down business prospects for Thermax through industrial capex. The risk in order inflows is thus skewed to the downside in Macquarie’s view.

FGDs – some positives, some negatives: CERC staff paper recognising the compulsory installation of Emission Control Systems (ECS) as a change-in-law event to allow cost recovery in PPAs bodes well for FGD prospects. At the same time, ongoing discussion within the government for extension of timeline to 2024 poses a risk for Thermax, considering its late participation in NTPC tenders and low win rate so far (won 2GW out of total 65GW ordered in the market).

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Where could we go wrong? Chemicals segment could support Thermax’s earnings given its high 18-20% margin (contributed 7% of revenue and 21% of EBIT in FY20) and ramp-up after capacity expansion. However, the margin is likely to moderate with specialty chemical mix normalizing from hereon.