Revival in capital goods sector

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Engineering high growth
Jitendra Kumar Gupta / Mumbai May 14, 2010, 0:20 IST

Better demand, order inflows suggest turnaround for capital goods companies.

India’s industrial production has improved consistently in the recent past, having grown at an average rate of 15 per cent in the first three months of CY2010. More important, the capital goods index (which reflects demand for machinery and other heavy equipment used in industrial activity) has grown at an average rate of 42 per cent. So, what does this mean for the country’s capital goods makers? After all, the sector saw tough times in 2009.



The lag effect
“Generally, if the capital goods index is showing strong growth, it will lead to growth in other industries or a broad revival of private capex, which may take another three-four months,” says CARE Ratings Chief Economist Madan Sabnavis.

In the March 2009 quarter, India’s gross domestic product growth fell to 5.8 per cent as against 8.6 per cent in the same quarter of the previous year. This was also one of the reasons that India’s index of industrial production growth was just one-two per cent in the first half 2008-09.

However, as the economy recovered, private and industrial capex started picking up a little in some industries. This should now gain momentum.

“Growth in industrial figures is encouraging. However, due to the time lag, a broad recovery in industrial capex is yet to be seen. A part of recent growth is due to infrastructure and power capex. Many companies in the industrial segment are still waiting for expansion (of capacity) even as real demand stabilises, which will happen only over the next two-three quarters,” says Sundaram BNP Paribas Mutual Fund’s Capex Opportunities fund manager Srividhya Rajesh.

Signs of revival
Analysts say a recovery is taking place in the capital goods sector, too. “All the four companies we interacted with, namely Areva T&D, Thermax, Crompton Greaves and Havells, confirmed that execution of existing projects has improved as clients want projects to be speeded up,” Macquarie Research’s engineering sector analyst, Inderjeetsingh Bhatia wrote in a recent note.

The execution rate of major engineering companies had dipped to five-six per cent in the quarter ended December 2009. This is expected to rise to 20 per cent in the March quarter.

STRONG EARNINGS OUTLOOK

FY11E

 Order /
sales #
(x)		 Earnings
CAGR **
(%)		 Industrial
segment *
(%)
PE
(x)		 EV /
EBITDA (x)
ABB 22.7 14.5 1.4 42.4 38.0
Areva T&D 23.9 12.5 1.4 40.0 40.0
BHEL 20.4 16.0 5.1 29.6 19.0
Blue Star 16.4 12.0 0.7 20.0 80.0
Crom. Greaves 16.9 10.0 0.3 19.0 15.0
L&T 22.3 14.0 2.7 26.1 42.0
Siemens 22.4 13.0 1.6 25.0 39.0
Suzlon 44.5 16.0 0.4

NA

38.0
Thermax 23.9 12.0 1.6 39.0 85.0
Voltas 16.3 10.9 0.9 27.0 77.0
* indicates share as a percentage to total revenues ** over next two years
(FY 11 and FY 12) # reflects latest order book to FY/CY 2009 revenues as applicable
Source: Analysts estimates

Notably, Crompton Greaves, L&T, Siemens, ABB and Thermax have seen order inflow from the industrial segment improve in the last three-four months and are now in a better position due to enhanced visibility and relatively lower commodity prices. Analysts say companies are likely to maintain the momentum in FY11 as well.

Heavyweights
Among companies that stand to gain are L&T, as its order book, execution and margins are seen improving. Thermax is a preferred choice of analysts. The company will also benefit from its foray into higher capacity power equipment. Higher industrial capex will also drive growth for Crompton Greaves, which has already benefited from from its leadership in the power transmission & distribution equipment segment despite stiff competition. However, the only concern is high exposure to the European markets.

Most analysts are concerned about ABB due to weak execution, cost overruns, tepid order inflow and a decline in margins. Also, in view of current valuations and earnings expectations, ABB’s stock looks expensive. In case of BHEL, India’s largest power equipment maker, although the revenue visibility is good, the company may face challenges from increasing competition.

Analysts have a buy recommendation on Voltas and Blue Star, which they believe will benefit as a result of their exposure to the industrial segment and an improving private capex.

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