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Cost pressures impact margins

Thermax margins were lower than expectations at 6% in Q1FY22 vs our estimate of 8.7%, impacted by normalisation of fixed cost and employee expenses. Despite headwinds, consolidated order intake was healthy at Rs16.9bn with order book of Rs61.1 (1.2x TTM sales). The company has taken various strategic technology collaborations in waste-to-energy, fuel cell and solar film segments. Factoring in the margin stress, we cut our FY22E and FY23E earnings by 14% and 2%, respectively. We have adopted SoTP-based valuation given different growth, margin and return outlook of the segments. We maintain HOLD rating on the stock with revised target price of Rs1,431 (previously: Rs1,506).

* Steady execution, lower than estimate: Environment segment registered strong revenue growth of 115% YoY to Rs1.8bn (Isec:Rs2.5bn), energy segment grew 52% YoY to Rs7.6bn (Isec:Rs8bn) and chemical segment grew 45% YoY to Rs1.2bn (Isec: Rs1.2bn) resulting in 58% YoY revenue growth to Rs10.5bn. Order intake grew 178% YoY to Rs16.9bn in Q1FY22. Current orderbook at Rs61.1bn (1.2x TTM sales) provides visibility. We believe the logistical bottlenecks in terms of container availability would have impacted the overall execution.

* We believe margins have been impacted due to cost pressures: Overall EBIDTA margin stood at 6% in Q1FY22 vs our estimate of 8.7% and Q4FY21 margin of 8.9%. Normalisation of other expense and employee cost has impacted the overall margins. The major impact is from environment with 1.5% (Isec: 6%), energy 3.7% (Isec: 8.5%) and chemicals at 17.6% (Isec: 19%).

* Demand from core sectors and short cycle orders will support growth: Demand from core sectors like cement, steel and refinery is likely to be healthy. The company is also focusing on short cycle low-ticket sized orders and services which will enable it tackle any near-term lull in demand efficiently. Drive towards improvement in collections and margins may continue supporting the cashflow.

* Maintain HOLD, rich valuation and cost pressures: The company is currently trading at a rich valuation of 52.8x FY22E and 37.8x FY23E earnings. Strategic growth initiatives in new growth segments will open up new long-term opportunities. Given varied growth, margin and return trajectory of the three segments, we have used SoTP valuation methodology. Due to strong growth prospects, high returns and margins under chemicals, which is at lower utilisation currently, we assign 60x FY23E core multiple, environment at 45x and energy at 30x multiple. We maintain HOLD rating on the stock with revised SoTP-based target price of Rs1,431 implying 39x FY23E earnings.

Outlook and valuation

There has been a positive shift in the domestic demand landscape recently, which may slow down due to the second wave of covid. However, the environment is likely to normalise H2FY22 onwards. Given the strong growth prospects under chemicals which is under-utilised currently and focus towards high margin specialty segment, we assign 60x FY23E core earnings multiple to this segment. Environment segment growth and returns are also poised to improve with focus on water and air pollution solutions, hence, we assign 45x multiple.

Energy segment growth outlook is healthy and recovery from overseas subsidiaries will enable overall improvement in margins and returns of this segment, hence, we assign 30x FY23E core multiple to this segment. Improvement in gross margins, turnaround in overseas subsidiaries and large order finalisations will be key re-rating catalysts for the stock.

Key risks: (i) Delay in normalisation of the lockdown, (ii) continuation of loss from overseas subsidiaries and (iii) reduction in order intake impacting the overall growth.

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