Thermax: Capex play

Thermax's engg segment grew handsomely in Q2

Thermax has turned in splendid numbers for the September quarter. Net sales and services were up by a strong 40 per cent year on year at Rs 307.84 crore, while the earnings before interest, tax and depreciation (EBITDA) soared by 130 per cent to Rs 37.7 crore.

The company has managed to keep costs in check and, as a result, the EBITDA margin has seen a smart rise of nearly 500 basis points.

With companies in the iron and steel, cement, refining and chemicals sectors expanding capacities and numerous energy-intensive firms opting for captive power plants, Thermax has had a strong orderbook position.

The market has obviously been expecting the company to take advantage of the turn in the capex cycle: the stock has seen a 50 per cent gain since mid-June and, not surprisingly, was up three per cent in Friday's trading at Rs 907.

The capacity expansion in Indian industry is helping Thermax's engineering segment, which contributed significantly to the top line in the September quarter with a growth of 56 per cent.

The environment division, on the other hand, saw a more sedate growth of around 21 per cent. The other factor driving the good performance has been the company's ability to manage input costs.

In FY05, the sharp increase in input prices, mainly steel, had resulted in raw materials to sales ratio rising substantially (around 500 basis points). This September, however, raw materials to sales has actually fallen to 65.8 per cent from 67.13 per cent in September 2004.

That has helped Thermax post a net profit of Rs 25.31 crore compared with Rs 10.83 crore in Q2FY05. At the current price of Rs 907, the stock trades at around 20 times estimated FY06 consolidated earnings and around 15 times estimated FY07 earnings.

While the valuation is not inexpensive, Thermax is in a good position to capitalise on the continuing industrial project activity.

AIA Engineering float

The AIA Engineering IPO is expected to raise between Rs 130 and Rs 148 crore depending on the issue price, which is in the Rs 275-315 band. With the issue proceeds, AIA plans to increase capacity, and tap the global mining and utilities markets and strengthen its position in the global cement industry.

The Rs 228 crore engineering firm is a niche supplier to the core sector. It manufactures mill internals, which include components such as grinding media, liners, mill parts among others.

The products are used for crushing and grinding applications in cement and mining companies, and thermal power plants. AIA's major clients include thermal power stations, ACC, Birla group and state electricity boards.

It also exports to global cement majors such as Holcim, Lafarge and Cemex. The company is promoted by a technocrat and is professionally managed. AIA also claims to have a dominant market share in the domestic market.

But these strengths are not being translated into consistent bottomline growth. For example, in 2004-05, top line increased 31 per cent, whereas pre-tax profit remained flat.

The culprit seems to be its manufacturing cost, which has gone up in 2004-05 to 74.6 per cent of sales from 72.6 per cent in 2003-04. Though it may not have much competition in India, if a foreign company starts selling similar products, then it will lose some market share.

The company has posted a net profit of about Rs 14.5 crore in the first half of 2005-06. If it maintains that momentum for the second half, this year's EPS works out to Rs 17. At that price, the issue price is discounted between 16-18.5 times, which appears high.

Commodity: Cooling effect?

A question that is becoming increasingly relevant over the last few weeks is whether the once-buoyant commodity sector is showing distinct signs of cooling off. Clearly, earnings growth has taken a beating in the second quarter of 2005-06 compared with the growth recorded in the past five quarters.

Several factors have contributed to this deteriorating business environment "" capacity, both in India and overseas, has been ramped up significantly over the past 18 to 24 months.

For instance, in the steel industry, Chinese capacity is set to reach 490 million tonne at the end of 2005 compared with 257 million tonne at the end of 2003. Another problem plaguing the commodity sector has been the relentless pressure on margins owing to rising input costs.

Rising steel capacity has led to product prices, such as hot rolled coils, dropping to $450-460 a tonne currently compared with almost $650 a tonne, at the height of the commodity boom in August-September 2004.

This has resulted in a steep fall in earnings growth for this industry "" aggregate net profit of this industry fell 16.51 per cent in the September 2005 quarter, despite net sales expanding 2.75 per cent.

In contrast, aggregate net profit grew 204.07 per cent, despite aggregate sales expanding only 52.35 per cent in September 2004.

Meanwhile, in the aluminium industry, margins have been hit by rising input costs nullifying improved product realisations. Aggregate profit fell 2.43 per cent in the second quarter of 2005-06 compared with an 8 per cent expansion in sales.

In contrast, aggregate industry profit grew 38.23 per cent despite aggregate sales expanding 50.41 per cent in September 2004 quarter. A similar trend was also observed in the cement industry.

However, a key exception to this general trend has been agri-commodities such as rubber and sugar. Prices for both these products have been firm thanks to supply lagging behind demand growth.

With contributions from Shobhana Subramanian and Amriteshwar Mathur