>THERMAX INDIA: Capex analysis indicates a weak order outlook

■  As a late-cycle play, Thermax is unlikely to benefit from the nascent economic recovery.
Engineering and construction firm Thermax derives c80% of its orders from mid- to latecycle
capex by sectors like metals, cement, refineries and power. As such, we do not see the
company benefiting yet from India’s tentative economic recovery, which remains fragile and
barely past the bottom of the cycle. We discuss several leading indicators in this report and
highlight that industrial production growth picks up only after 3-4 quarters of a rate cut, while
gross capital formation growth picks up only when the rate cycle has bottomed.


■  Capex analysis indicates a weak order outlook. Captive power addition, a key demand
driver for Thermax, is likely to closely track industrial capex, because other drivers, such as
high merchant rates and cost advantages, are fading. We discuss capex outlook in four key
sectors (e.g., metals, cement, refineries and power) and estimate that capex in these sectors
on average will fall c15% in FY13 and c9% in FY14. Assuming a 12-month lead time in
ordering, we forecast Thermax order inflow to decline by c16% in FY12 and c6% in FY13.


■  Earnings still to bottom; consensus appears bullish: Due to weak order inflow in FY12-
13, we expect revenue to fall c10% in FY13 and EBITDA margin to fall c130bp in FY12-
13. We note that consensus appears bullish, as it is factoring in only a 2% sales decline in
FY13 and a c40bp margin decline in FY12-13, even when margin has already fallen by
c90bp in 9M FY12. While margin may benefit somewhat from a potential easing in steel
prices going into FY13, the decline in volumes and pricing pressure is likely to prevent its
earnings from improving. Hence, we remain c12%/21% below consensus on FY12/13 EPS.


■  Initiate UW with a TP of INR400; recent derating justified: While Thermax is trading at
a 33% discount (on consensus) to its historical 12-month forward PE, the recent derating
seems justified, given the deterioration in its returns and growth prospects. On our FY13
EPS, the stock appears expensive, trading at a c18.4x PE vs. a sector average of c11.6x, and
we believe potential earnings downgrades will drive the stock lower. Thus, we initiate
coverage on Thermax with an Underweight rating. Our TP of INR400 is derived from our
preferred EVA methodology and implies a 12-month forward target multiple of c14.9x.


To read report in detail: THERMAX INDIA
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