Best Transformer Stocks for Your Watchlist

In last one the 'green' has painted the markets red.

Olectra Greentech is up about 3x. Inox wind is up about 6 times. Websol Energy is up nearly 8x. Insolation Energy is up 11x.

Most of these stocks are commanding a PE of over 100. The multiples can be questioned in the backdrop of economics of some of these businesses.

However, the euphoria is not for no reason. India aims for 500 GW of renewable energy installed capacity by 2030. This is an almost 3x increase from current levels.

Renewables are expected to account of 50% of cumulative power by 2030.

All the engines - solar, wind, biomass, waste to energy, green hydrogen are on firing mode.

Amid this huge opportunity, value investors have a dilemma. Entering or participating in this rally, at these valuations is against the DNA of a value investor.

If this is your constraint too, this article is for you.

We will discuss a lesser known and yet to be acknowledged participant in this rally. But before I get specific, I want to share with you Elon Musk's statement, that is nothing short of a warning.

He said that without transformers, the AI and EV revolution can not take off. Chips are the new gold now, but transformers are going to be the next gold.

With the technology growing in leaps and bounds, the world is going to need more transformers and electricity.

• "My not-that-funny joke is that you need transformers to run transformers. You know, the AI is like... There's this thing called a transformer in AI... I don't know, it's a combination of sort of neural nets... Anyway, they're running out of transformers to run transformers.
  
  Then, the next shortage will be electricity. They won't be able to find enough electricity to run all the chips. I think next year, you'll see they just can't find enough electricity to run all the chips.
  
  The simultaneous growth of electric cars and AI, both of which need electricity, both of which need voltage transformers - I think, is creating a tremendous demand for electrical equipment and for electrical power generation."
  
  - Elon Musk

To appreciate this, we need to understand the role of transformers in this clean energy revolution.

Transformers shift the voltage - step it up or down to meet the needs of transmission and distribution.

The renewable energy sources can be erratic depending on weather and time. As such, the relevance of transformers in the evolving energy mix gets even stronger. That's because they have to adjust to irregular energy input and supply.

They should be able to perform in harsh environmental conditions, that come along with reliance on wind and solar energy.

We have seen companies like Apar Industries doing well amid all this electrification drive.

To further search for beneficiaries, we need to look at stocks in the transformer value chain.

So let's do that.

For effective performance of transformers, you need transformer oils. They serve as coolant, electric insulators and raise efficiency and longevity of transformers.

And this is where Savita Oil comes into picture.

The company claims to be the only global manufacturer of mineral, natural and synthetic ester-based transformer oils, catering to power, distribution and instrumentation transformers, along with switchgears and circuit breakers.

Its customers range from domestic to global transformer makers, electricity boards and power plant operators - BHEL, Power Grid, Hitachi, Tata Power, ABB, and Toshiba.

With one third market share in the domestic transformer oil, the company stands to benefit from India's electrification drive.

Not just from fresh capacity additions but grid modernisation as well.

Almost 75% of its sales come from transformer oil, white oils and specialty products, and the rest from auto and industrial oils.

Along with the tailwinds in end industries, the company is getting stronger with better product mix. It's working on getting into coolants for EVs and batteries.

The company has a debt free balance and has generated healthy return on capital invested, of over 20% and above in last seven years barring FY20.

The also company has a history of returning cash through both buybacks and dividends.

So, what's the catch?

Well, the profits are susceptible to fluctuations in raw material price, which is a crude derivative. The business is working capital intensive.

And since 80% of raw material is imported, and currency fluctuations can have an impact too. While it enjoys healthy market share, competition is intense too.

Along with Savita Oil, you should also look at Panama Petrochem that is into similar products.

The company is undertaking capex through internal accruals. Besides, it's targeting value added products at 85% of revenues in three to five years.

It's return ratios are over 25% and has a debt free balance sheet.

Do not consider these as recommendations, but these deserve to be on your watchlist.

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Warm regards,


Richa Agarwal
Editor and Research Analyst, Hidden Treasure
Equitymaster Agora Research Private Limited (Research Analyst)