Asian Overcapacity And Tariffs Will Erode Refining Margins

Key Takeaways

• Weak demand in core Asian markets and shifting industrial spending patterns threaten Sulzer's growth prospects and expose its revenue base to further volatility.
  
• Rising regulatory costs and limited operational improvements increase risks to profitability, with modest performance in high-margin segments challenging profitability initiatives.
  
• Strategic focus on sustainable technologies, service-driven revenue, and operational improvements positions Sulzer for resilient, recurring growth and stronger profitability amidst global decarbonization and regulatory trends.

Catalysts

Develops and sells products and services for fluid engineering and chemical processing applications worldwide.

• Persistent overcapacity in the refining and petrochemical sectors in Asia, especially China, is set to remain unresolved through 2025 and 2026, leading to continued weakness in Chemtech's core business and potentially shrinking Sulzer's total addressable market; this is likely to suppress group revenue and earnings growth over the medium term as demand for legacy industrial products erodes.
  
• Rising costs due to tightening environmental regulations, additional tariffs, and increasing ESG compliance requirements are expected to put incremental pressure on Sulzer's operating expenses and erode net margins, with the group indicating that only very reasonable cost measures are being taken in Chemtech despite falling profitability, leaving the company exposed to further margin contraction.
  
• The accelerating shift of capital expenditure and major industrial projects from Europe to Asia, where Sulzer's market position is weaker and competition more intense, limits future growth opportunities; attempts to compensate with smaller markets and smaller projects in China risk lower profitability and reduced pricing power, weighing on long-term sales quality and returns.
  
• The company's ongoing dependence on cyclical end markets such as oil & gas, power generation, and chemicals makes its revenue base increasingly volatile at a time when secular decarbonization trends and electrification are disincentivizing new projects in these fields, implying heightened risk of earnings contraction and order backlog depletion as major investments are delayed or cancelled.
  
• The slow pace of operational leverage improvements in the high-margin Services division, as evidenced by only modest EBITDA margin gains despite double-digit sales growth, highlights execution risks for Sulzer's profitable growth strategy; if digitalization or commercial excellence initiatives fail to deliver as planned, structural margin improvement and sustainable earnings growth will remain elusive for several years.

Sulzer Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Sulzer compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Sulzer's revenue will grow by 3.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 7.6% today to 9.3% in 3 years time.
• The bearish analysts expect earnings to reach CHF 362.3 million (and earnings per share of CHF 10.63) by about August 2028, up from CHF 272.8 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 9.5x on those 2028 earnings, down from 18.9x today. This future PE is lower than the current PE for the GB Machinery industry at 22.9x.
• Analysts expect the number of shares outstanding to decline by 0.06% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.39%, as per the Simply Wall St company report.

Sulzer Future Earnings Per Share Growth

Risks

• Long-term global trends such as decarbonization, energy transition, and increased investments in renewable energy and sustainable infrastructure are driving demand for Sulzer's flow control and separation technologies, which may boost both top-line revenue and long-term growth rates.
  
• Ongoing urbanization and rising water scarcity, along with tighter environmental regulations, are expanding the addressable market for Sulzer's advanced water treatment and wastewater management solutions, supporting recurring revenue streams and lowering end-market cyclicality.
  
• The company is demonstrating consistent year-over-year profitability improvements, growing above market rates, and achieving rising EBITDA margins as a result of disciplined execution of its operational excellence and cost optimization initiatives, which points toward sustainable improvements in net margins and earnings quality.
  
• Sulzer's strategic shift to higher-margin, resilient service and aftermarket offerings-now representing approximately 50% of order intake-provides a foundation of recurring revenue that is less vulnerable to cyclical project delays, strengthening both cash flow and earnings resilience.
  
• Robust investment in R&D and innovation, including next-generation energy optimization, carbon capture, and biopolymer technologies, is enabling Sulzer to take advantage of secular shifts toward digitalization and green industrial processes, enhancing pricing power and supporting future revenue and margin expansion.

Valuation

• The assumed bearish price target for Sulzer is CHF89.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Sulzer's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CHF200.0, and the most bearish reporting a price target of just CHF89.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be CHF3.9 billion, earnings will come to CHF362.3 million, and it would be trading on a PE ratio of 9.5x, assuming you use a discount rate of 5.4%.
• Given the current share price of CHF152.8, the bearish analyst price target of CHF89.0 is 71.7% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.