The distinguishing feature of Thermax is that it manages its business from the cash flows that it generates internally. Despite this, it is a market leader in its business proposition.
A take on the vision and values
The latest annual report gives a point by point notation of the vision and values of Thermax Ltd. The three notable standouts here are "Deliver what is promised to all our shareholders", "Being true to ourselves in our personal and professional dealings and doing what is right at all times" and "Nobody will exploit the company for personal gain or gratification." Since the promoter family controls close to 62% of the outstanding equity, (with the chairperson's mother Anu Rohinton Aga personally holding 5.7% of the equity), the first of the commendable values mentioned here makes for eminent sense. It will help if the management spelt out upfront clearly the bonus share issue policy of the company, or even the dividend payout policy for that matter. It currently has none.
And considering that this company believes in the hear no evil, speak no evil, and see no evil philosophy, how come it got embroiled in a business dispute with Purolite International, a US competitor, concerning inter alia the trade secrets of Purolite, and involving a payout of Rs 1.7 bn to them? The management claims that the net of tax effect on this count is limited to Rs 1.2 bn. What is the guarantee that the income tax department will allow this payment as a legitimate business deduction for tax purposes?
Furthermore one of the schedules mentions that the company has during the year paid Rs 0.5 m to Mrs Aga and Rs 0.12 m to Mrs Pudumjee as rent for premises and not as stated. It has also paid Rs 2.2 m as rent to Mr. Pheroz Pudumjee as rent for the premises taken on lease. The company also maintained a security deposit of Rs 4 m with Mrs. Aga and Rs 1.8 m with Mr. Pudumjee in this respect. No security deposit has been taken from Mrs. Pudumjee, and besides, there appears to be inconsistency in the amount of security deposit maintained in conjunction with the rent paid to Mrs. Aga and Mr. Pudumjee respectively.
How it earns its living
Whatever, this 30 years young company is primarily into manufacturing critical equipment (boilers/heaters/power and cooling and heating) for the energy sector which brought in 77% of its revenues, while the environmental business comprising Air Pollution Control, Chemicals and Water and Wastewater Solutions accounted for the remaining 22.7%. The revenues basically appear to comprise income from turnkey projects. One of the notes to the accounts states that the aggregate amount recognized as Contract Revenue for the year is Rs 38.9 bn against Rs 21.2 bn previously.
The gross sales revenues per-se increased sharply to Rs 49.3 bn (domestic turnover of Rs 38.6 bn and exports of Rs 10.6 bn) from Rs 30.9 bn previously, with income from operations and income from investments rolling in Rs 950 m and Rs 523 m respectively, against Rs 971 m and Rs 500 m previously. The income from operations in the main includes sale of scrap, miscellaneous income and exchange difference income. These items though significant in themselves are unquantifiable, especially exchange income which can swing either way. The bulk of the other income comes from liquid investments which totaled Rs 1.4 bn at year end. Tied investments added up to another Rs 2.6 bn. (Of the latter, three investments account for the bulk of the pickings-Thermax Netherlands Rs 1.4 bn, Thermax (Zhejiang) Rs 476 m, and Thermax Babcock & Wilcox Rs 354 m.
Managing with what it has
The very good news of-course is that in the last 10 years the company has been largely debt free, especially when taking into account that the gross block has ballooned from Rs 1.7 bn in end 2001-02 to Rs 7.2 bn in 2010-11, and the gross current assets likewise from Rs 2.3 bn to Rs 20.8 bn. From the look of things it also appears that the management does not believe in aligning the equity base in line with the increasing operational base of the company. The share capital has remained kaput at Rs 240 m over the last decade, while the reserves and surplus has rocketed to Rs 12.7 bn from Rs 3.2 bn over the time span.
A complex revenue generation
Given the very nature of its business it becomes impossible to figure out how exactly it books its revenues as there is no inter-connection with what it manufactures and the final outcome. In the main it makes boilers and chillers of various capacities, air pollution control plants, waste and water treatment plants, and ion exchange resins from its three manufacturing plants in Maharashtra and two in Gujarat. (Separately two new plants, in Gujarat and Maharashtra, to manufacture performance chemicals, and air pollution control equipment appear to be in the making)'.
Sales however are booked under the subheads of 'Energy' and 'Environment' in the schedule showing the breakup of information of 'primary business segments'. Then there are of course the many inter-se transactions on revenue and capital account with other group companies. And, further, what it manufactures appears to be way below what it can produce on paper.
It has for example an installed capacity to make 22,410 MT of boilers above 30 MT, but production was a mere 4,351 MT. Similarly for boilers below 30 MT, it produced 2,141 numbers, against a capacity of 3,441 numbers. In the case of ion exchange resins the figures were 19,855 MT and 36,161 MT respectively. In other words there is substantial under utilization of its installed capacities. It is not known whether the company has added to its productive capacity during the year, as the installed capacity figures for the preceding year have not been furnished. But the expenditure on gross block during the year was Rs 550 m. On top of all this the company is now in the process of bringing to life a new JV with Babcock and Wilcox to manufacture supercritical boilers.
The margins are thin
Whatever, the margins relative to revenues is thin. The company clocked a profit before tax of 12% against 9% previously, as a percentage of total income. What has to be considered here however is the contribution of 'other income' to the pre-tax profit. Such other income comprising 'income from operations' and 'income from investments', accounted for 26% of pre-tax profit against a substantial 53% previously. It is a grizzly market out there - that is for sure. But the company had the good fortune of being able to get customers to fork out cash up front for the wares of the company that they have taken a fancy to. At year end customer advances against orders placed totaled Rs 9.6 bn against Rs 10 bn previously. (But at the same time this was countenanced by trade debtors at year end amounting to a humungous Rs 10 bn). It also believes in keeping large year-end cash balances.
It also had to contend with an extra heavy demand on it resources during the year. It had to plonk down Rs 1.9 bn into the share capital of its subsidiaries and joint ventures during the year. But this cash infusion was partly facilitated by a draw-down of its liquid investment portfolio by Rs 1.7 bn. It even found the wherewithal in trading in debt instruments with the company buying Rs 8.3 bn debt and selling Rs 10 bn worth. (If it made any money in the bargain it is not stated upfront). With the gross block expenditure also to be financed, the company had to finally resort to taking on a year-end debt of Rs 480 m, albeit after an absence of 9 years! It is quite clear from the management of its funds that the company believes in living within the resources at hand to the extent possible.
A surfeit of subsidiaries
If the size of a company is in relation to the numbers, then Thermax is a very large company. Thermax has 19 subsidiaries and/or step subsidiaries including two companies coming under the nomenclature of joint ventures. Of this lot, 12 are of the firangi variety. It has a majority stake of 51% in the two joint ventures and a 100% stake in the subsidiaries. (The wonder is that it has a majority stake in the two JVs with foreign partnership where the foreign partner has the control over the technology being imparted). It has published the brief financials of 11 companies. Two of the subsidiaries - based out of Hongkong and India respectively are in the process of being iced and hence have no financials to show. These two companies are therefore excluded from the list.
It also went into overdrive during the year, and in what it considers a coup, acquired four companies based out of Denmark and the UK. To facilitate the acquisition and to round out the picture, it incorporated two companies - based out of the Netherlands, and Denmark-the latter being a subsidiary of the former. (Netherlands also appears to be some sort of a tax haven). That makes for a grand total of 19. The Danish company, Danstoker, which Thermax states is a leading European boiler manufacturer of 75 years standing, especially in the renewable energy space, along with its add ons including its German subsidiary Omnical, were acquired for an enterprise value of US$ 41.8 m. The financials of these six companies will be available in the next annual report.
The subsidiary financials
The financials of the companies on offer do not a pretty picture make. The company with the largest capital base of Rs 965 m is the JV with Babcock and Wilcox, but this entity has yet to go on stream. Next in line is the subsidiary based out of China with a capital base of Rs 509 m - but it has just got off the starting block. The company boasting the largest top-line is Thermax SPX Energy (a energy conservation cum efficiency JV in which Thermax has a 51% stake) with revenues of Rs 2.4 bn, but with a 'scraping the bottom of the barrel' pretax profit of Rs 51 m. Next in order is Thermax Engineering Construction with a top-line of Rs 1.2 bn and a pretax profit of Rs 94 m. The American subsidiary, which is in reality a step down subsidiary for whatever reason, also notched up some top-line, but the bottom-line is etched in red ink.
The other subsidiaries are merely of the 'fly in the ointment' variety including the Mauritian spinoff which may be some dummy investment outfit (as all Mauritian offspring are). But if its incorporation had any purpose it has yet to show. The game changers of the future in all likelihood will be the venture with Babcock, the Danish coup and the Chinese adventure. How the parent will dovetail these interests into its main body only time will tell. But await a clarion call here nevertheless.
Sounding a note of caution
For the present the managing director, Mr Unnikrishnan, has sounded a note of caution. The company faces some major challenges he says. The order intake position is only marginally higher at the turn of the year. The industrial investment climate around the world is not offering room for optimism in the short term either. There is some sort of a credit squeeze playing out on the infrastructure sector to which it caters. But commodity prices continue to rule high putting a pressure on margins. And the company is facing uneven competitive pressure from China in the power sector-which may extend to other sectors too.
Does this make it look like a scary cat picture or something? Why then is the company simultaneously expanding its manufacturing capacity in all directions please?
Disclosure: I hold 106 shares in Thermax Limited
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.