Power Grid Expansion And Backward Integration Will Eventually Outweigh Execution And Margin Risks

Catalysts

About Transformers and Rectifiers (India)

Transformers and Rectifiers (India) designs and manufactures power and special duty transformers for utilities and industrial customers, supported by growing backward integration capabilities.

What are the underlying business or industry changes driving this perspective?

• Although the domestic power grid expansion and utility capex provide a multi year demand runway, site unreadiness and monsoon related disruptions highlight execution fragility. These factors could continue to defer revenue recognition and suppress operating leverage, weighing on near term revenue and EBITDA margins.
• While the company is adding substantial capacity at Moraiya and Changodar to participate in rising transmission and distribution investments, delays in commissioning and ramp up risk under absorption of fixed costs. This may constrain the ability to translate the strong order pipeline into earnings growth.
• Although backward integration into CTC, bushings and tank manufacturing can structurally reduce dependence on volatile suppliers and improve cost control, any slippage in project timelines or technical stabilization could prolong current raw material bottlenecks. This may keep gross margins below guided levels.
• While specialization in high value special duty transformers positions the company to benefit from global industrial and infrastructure projects, concentration in a limited set of large customers and geographies may expose it to lumpy order flows and pricing pressure. This can create volatility in revenue and net profit.
• Despite a robust order book and stated intent to become net debt free in 18 to 24 months, sustained working capital lock up from higher inventories, retention receivables and delayed dispatches could slow deleveraging and cap earnings accretion from lower finance costs.

Assumptions

This narrative explores a more pessimistic perspective on Transformers and Rectifiers (India) compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Transformers and Rectifiers (India)'s revenue will grow by 28.9% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 11.2% today to 9.8% in 3 years time.
• The bearish analysts expect earnings to reach ₹4.7 billion (and earnings per share of ₹15.51) by about December 2028, up from ₹2.5 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as ₹5.4 billion.
• 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 34.4x on those 2028 earnings, up from 33.8x today. This future PE is greater than the current PE for the IN Electrical industry at 29.7x.
• The bearish analysts expect the number of shares outstanding to grow by 0.61% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 16.26%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistent shortages and regulatory bottlenecks in key raw materials such as CTC and bushings, even after backward integration comes on stream, could limit the benefit from the sector wide power capex upcycle and structurally cap throughput, directly constraining long term revenue growth and operating margins.
• Delays in commissioning and ramping up the Moraiya and Changodar expansions due to weather disruptions, equipment delays or execution issues could keep capacity utilization below targeted levels, reducing operating leverage and depressing EBITDA margins and earnings versus management’s medium term aspirations.
• Ongoing site unreadiness, logistical challenges and monsoon related infrastructure damage at customer locations could continue to defer dispatches, leading to elevated inventory, potential liquidated damages and weaker working capital cycles, which would pressure net profit and slow the path to becoming net debt free.
• Reputational overhang from the World Bank debarment and any spillover to other multilateral or export linked opportunities could limit access to higher margin international projects over the long run, reducing diversification and leaving earnings more exposed to domestic policy cycles and pricing pressure from Indian utilities.
• If industry wide competition intensifies in transformers during a prolonged investment cycle and the company remains disciplined on order intake duration and risk, it may forego part of the broader sector growth. This could result in a slower revenue trajectory and lower earnings than implied by current long term guidance targets.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Transformers and Rectifiers (India) is ₹334.0, which represents up to two standard deviations below the consensus price target of ₹412.5. This valuation is based on what can be assumed as the expectations of Transformers and Rectifiers (India)'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 ₹491.0, and the most bearish reporting a price target of just ₹334.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be ₹47.7 billion, earnings will come to ₹4.7 billion, and it would be trading on a PE ratio of 34.4x, assuming you use a discount rate of 16.3%.
  
• Given the current share price of ₹281.35, the analyst price target of ₹334.0 is 15.8% higher.
  
• 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.