THR - Thermon Group Holdings: Cash Flow Stability Through Strategic Acquisitions

2023-07-04 10:20:13 ET

Summary

• Thermon Group Holdings has seen a surge in its share price following strong earnings and guidance.
• Despite a high share price, Thermon maintains a P/E ratio of 26.6, suggesting fair valuation considering its growth prospects; the company's strong earnings performance and projected earnings guidance growth over the next two years position it well for long-term shareholder value.
• Thermon's balance sheet offers resilience during challenging macroeconomic conditions, with a 40% reduction in debt over the past three years.
• Thermon's acquisition strategy will create synergies and thus expand cash flows while also stabilizing them.
• Assuming my DCF figures, Thermon is currently undervalued resulting in a buy rating.

Thermon Group Holdings ( THR ) has recently surged following strong earnings and guidance. Although the share price is historically high, I believe that Thermon still remains a buy due to the company's strong future growth, solid balance sheet, undervaluation, and acquisition strategy which would produce compounding value for shareholders in the long term.

Business Overview

An international supplier of industrial process heating solutions, Thermon Group Holdings, Inc. works with numerous industries in the Americas, Latin America, Europe, Canada, the Middle East, Asia, and Africa. A wide variety of goods and services are provided by the business, such as thermal tracer solutions, automation and control networks, commercial heating and filtering solutions, temporary distribution of electricity and lighting, and heating products for transportation.

Electric heat tracing cables, steam heating solutions, instrumentation, project services, and software systems for heat trace control are all part of Thermon Group's portfolio. Under several brand names like Ruffneck, Norsemen, Cata-Dyne, and 3L Filters, they also offer filtration solutions, process heating solutions, and environmental heating solutions.

Financials

Thermon Group Holdings, Inc. currently has a market capitalization of $895.91 million and a return on invested capital of 7%. The stock is trading at $26.55, which is close to its 52-week high of $27.85. Despite this, Thermon Group maintains a P/E ratio of 26.6 based on GAAP, which is comparable to or better than its industry peers.

This P/E ratio suggests that the company may be fairly valued, considering its growth prospects, even though the metric itself appears relatively high.

While Thermon currently does not pay a dividend, the company effectively utilizes its free cash flow to drive revenue growth and demonstrate a positive trend in FCF recovery in recent years. As the company's cash flows stabilize and growth slows down, there is a possibility that Thermon may consider initiating a dividend payment or implementing a share buyback program. But, with high costs of revenue and minor net income, Thermon must be careful when rewarding shareholders as it may result in competition capitalizing on weakness if financial constraints arise through headwinds.

Earnings

Thermon has delivered outstanding results in Q4 , resulting in a significant surge in its stock price. Despite challenging macroeconomic conditions characterized by volatility and high rates, the company has shown remarkable resilience. By meeting earnings expectations and exceeding revenue projections by $8.3 million, with total revenues reaching $122.48 million, Thermon has demonstrated its ability to outperform during periods of profitability. This exceptional performance not only strengthens the company's position to navigate cyclical downturns but also supports its long-term business growth. With strong projected earnings guidance growth over the next two years, Thermon is in a strong position to produce long-term shareholder value.

Outperforming the Broader Market

Over the past 2 years, Thermon has outperformed the broader market, exemplifying the company's ability to allocate FCF to foster growth and recover from profitability declines.

Analyst Consensus

Thermon has received a strong buy rating from analysts in the past three months, indicating their confidence in the company's continued growth trajectory following its outstanding earnings performance. With an average one-year price target of $30, the stock is expected to have a potential upside of 12.49%. This suggests that investors have a positive outlook on Thermon's future prospects and anticipate further value appreciation in the stock.

Balance Sheet

Thermon's balance sheet is noteworthy, offering resilience during challenging macroeconomic conditions. In the last three years, the company has reduced its debt by 40%, leading to a comfortable interest coverage ratio of 10.25. With a current ratio of 2.28 and an Altman Z-Score of 3.88, Thermon demonstrates its ability to navigate present headwinds and suggests a promising future presence in the industry. These indicators highlight the company's financial stability and position it well for the coming decades.

Valuation

To conduct a thorough analysis, it was imperative to compute Thermon's Cost of Equity and Weighted Average Cost of Capital using the Capital Asset Pricing Model. Taking into account a risk-free rate of 3.84%, based on the 10-year treasury yield , I determined that Thermon's Cost of Equity is estimated to be 8.32%. This figure represents the anticipated return that investors demand to offset the risks associated with holding Thermon's equity.

Based on the aforementioned calculations, I derived Thermon's Weighted Average Cost of Capital to be 7.81%, which is lower than the industry average of 11.68% .

Based on a comprehensive analysis using an Equity Model DCF approach, specifically focusing on Free Cash Flow to Equity, Thermon is currently undervalued by approximately 5%, with a fair value estimate of around $28.05. This assessment was made considering a discount rate of 8.32% over a 5-year period. The valuation assumes consistent revenue and margin growth, driven by acquisitions and a competitive edge through innovation, resulting in a favorable outlook for the company.

Strategic Acquisitions Fostering Long-Term Growth

Thermon Group approaches acquisitions strategically, looking for chances that mesh with its expansion goals and strengthen its current business. Thermon concentrates on buying businesses that offer synergies in terms of technology, product portfolio, market presence, or client base.

Thermon Group's 2017 acquisition of CCI Thermal Technologies Inc. for $258 million CAD, is one instance of such acquisition. A well-known supplier of cutting-edge heating and filtration solutions was CCI Thermal Technologies. With the help of this acquisition, Thermon Group was able to broaden its product line and solidify its market share in the industrial heating and filtration sector, improving its ability to compete with other businesses.

By acquiring CCI Thermal Technologies, Thermon Group got access to a wider selection of heating products and solutions. These goods complement Thermon Group's current portfolio and do not compete with its present products, enabling uninterrupted expansion across all segments. Additionally, the acquisition increased Thermon Group's customer base and geographical reach, particularly in the Canadian market. Thermon's revenue streams will be increasingly diversified as a result, and the company will be able to enhance its brand recognition in Canada, which has a sizable market for construction supplies like electrical equipment.

Thermon Group was able to increase its total capabilities and competitiveness in the thermal management sector by merging the knowledge, technology, and market reach of the two businesses through this acquisition. By combining complementary fixed expenses and offering customers a wider range of products, this synergy allowed Thermon to improve its serviceable addressable market. Such expansions of margins along with profitability have allowed Thermon to improve cash flows which will compound into large gains which could be used to further outpace competitors.

With the intention of future acquisitions, I believe that Thermon will be able to further develop its portfolio and venture into new segments thus improving and stabilizing cash flows in the long term.

Risks

Technological advancements: Technology is advancing quickly in the sector where Thermon does business. Losing market relevance and competitiveness could occur if new technologies are not adapted or creative solutions are not developed.

Supply chain disruptions: Thermon purchases raw materials and parts for its products from a global supply network. Natural disasters, transportation challenges, or issues with suppliers might all cause supply chain disruptions, which could make it more difficult for the business to meet customer demand and raise expenses.

Conclusion

To summarize, I believe that Thermon is currently a buy due to the company's strong future growth, solid balance sheet, undervaluation, and acquisition strategy which would produce compounding value for shareholders in the long term.

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