Is Thermax’s hot valuation justified?

The Thermax stock trades at over 21 times 12-month forward earnings—a premium to rivals such as L&T
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First Published: Mon, Dec 24 2012. 01 34 PM IST
As compared with 60-70% of new orders between 2009 and 2011, this year, only 30% of orders for Thermax originated from the private sector. Photo: Priyanka Parashar/Mint
As compared with 60-70% of new orders between 2009 and 2011, this year, only 30% of orders for Thermax originated from the private sector. Photo: Priyanka Parashar/Mint
Updated: Mon, Dec 24 2012. 10 04 PM IST
Thermax Ltd’s stock has gained 56% this calendar year, the best performing constituent of the BSE Power index barring JSW Energy Ltd. What could be the reason for this exceptional rise?
One reason for the run-up—as with some other stocks in this space—is the reform push by the government, at least on paper. With pundits forecasting that the Reserve Bank of India will cut rates in the January-March quarter, there is optimism that investment demand will pick up in the coming months.
Thermax itself won a Rs.503 crore order on 3 December from a government company. In the three months ended September, after five straight quarters of decline, the company managed to increase its order inflows by 4% from a year ago to Rs.1,320 crore.
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However, despite this seeming bullishness, even investors aren’t all that convinced. On the day Thermax won the government order, the stock momentarily climbed to a 52-week high of Rs.639.90 before closing at Rs.605.50.
The reasons for this caution are not hard to find. These also explain why the rally in the Thermax stock may not be sustainable.
For one, the investment cycle among private sector companies is yet to take off. As compared with 60-70% of new orders between 2009 and 2011, this year, only 30% of orders originated from the private sector.
That is owing to the familiar reasons of fuel availability, land acquisition issues, environmental clearances and so on.
Moreover, in a discussion with Edelweiss Capital Ltd, the management itself said it “expects the CPP (captive power plant) market to drop by 15-20% to 1,200 megawatts in FY13E”. If capital goods companies are getting orders, it is mainly from the government sector, which may not be sustainable.
Secondly, the weak order inflows in the preceding quarters are starting to bite.
In the September quarter, Thermax’s revenue fell 8.5% from a year ago to Rs.1,192.4 crore and its operating profit fell 13.5%. Brokerage firms estimate that the company needs to get order inflows of Rs.1,500-1,600 crore every quarter to show revenue growth.
Add to this, problems such as declining margins owing to higher competition and underutilization of a new supercritical factory because of a lack of bids for products.
In that scenario, earnings will continue to remain under pressure in the medium term.
Hence, Thermax may find it difficult to justify valuations with the stock trading at over 21 times 12-month forward earnings, not only above its long-term average, but also at a premium to rivals such as Larsen and Toubro Ltd.
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First Published: Mon, Dec 24 2012. 01 34 PM IST
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