Capital goods index adrift, nibble warily

A slowdown in the economy has taken a toll on capital goods stocks with the S&P BSE Capital Goods (CG) index tumbling to a four-year low in trade today

A slowdown in the economy has taken a toll on capital goods stocks with the S&P BSE Capital Goods (CG) index tumbling to a four-year low in trade on Monday. Also impacting the sentiment was lower-than-expected net profit growth for the June quarter by sector heavyweights.

Among sectoral indices, the CG index was the top loser on Monday, down nearly four per cent or 287 points at 7,725, compared with a modest 0.1 per cent rise in the S&P BSE Sensex to 19,182. At these levels, the CG index is trading at its lowest point since April 2009. It has underperformed the market by falling 29 per cent so far in 2013, against a 1.25 per cent drop in the benchmark index.

Bharat Heavy Electricals Ltd (Bhel), Larsen and Toubro, SKF India, Crompton Greaves, Siemens and Thermax are trading lower by 1 – 19 per cent on BSE.

The aggregate net profit of 10 companies featuring in the CG index has declined 67 per cent to Rs 415 crore in the June quarter against Rs 1,254 crore during the corresponding quarter last year, data shows. Net sales, too, have slipped seven per cent to Rs 32,498 crore during the recently concluded quarter over the previous year.

Says Deven Choksey, managing director, KR Choksey Securities: “Till the time the project revival taking place in the country, the capital goods stocks will be directionless. We are entering into a capitulation stage right now because of indecisive execution abilities in the country.” “The government's recent positive announcements are unlikely to result in a V-shaped recovery in the capex (capital expenditure) cycle. Rather, India first needs to address some structural issues (land acquisition, overleveraged private sector, changes in contract terms, etc), which we expect to take at least 18 months,” points out Aditya Bhartia of Espirito Santo Secutities in a July 2013 report.

“While we do not dispute the potential for the railways, urban infrastructure and hydrocarbons sectors to spur an investment surge, we do not think this will be sufficient to make up for the slowdown in other more capital intensive sectors (power, highways). Margin pressure could also play spoilsport,” he states.

Bhel disappoints
Among the individual stocks, Bhel has tanked 19 per cent to Rs 121, its lowest level since December 2005, after reporting a sharp 50 per cent year-on-year drop in its net profit at Rs 465 crore for the first quarter ended June 30, 2013, due to lower sales. The power equipment maker had clocked a net profit of Rs 921 crore in the year-ago period.

The company’s net sales declined 31 per cent to Rs 6,353 crore for the quarter from Rs 8,326 crore in the same period a year ago, according to a regulatory filing. Analysts, on an average, had expected the state-run company to report a net profit of Rs 794 crore on net sales of Rs 8,043 crore for the quarter.

“Bhel is unlikely to sustain its revenue growth traction on such a high base, considering the subdued order placement activity and distorted demand-supply dynamics in the BTG (boiler turbine generator) industry, along with the absence of similar level of scalability options in its other business segments. Also, compression in margins is likely to lead to earnings CAGR (compound annual growth rate) decline of 17.5 per cent over FY13-FY15E, compared to a 5.2 per cent CAGR over FY11-FY13, thereby capping its valuation,” said Chirag Muchhala, senior research analyst-institutional equities at Nirmal Bang.

Meanwhile, reports suggest the disinvestment department has shelved plans to sell a stake in the company, citing valuation concerns and a depleting order book.

The road ahead
Analysts remain cautious on this space and prefer to wait-and-watch how the economy plays out over the next few months before committing fresh money in this space.

Points out Choksey: “We are certainly not in a hurry to buy any of the stocks from this space. However, having said that, we remain selective on these stocks. For the time being, we may stay away from the government-owned companies, but may probably look at some private sector names to buy into the portfolio. Some of the good quality names include Siemens, ABB, Larsen and Toubro. If the situation turns normal, these stocks could see a buy recommendation.”

Kunal Sheth, an analyst with Prabhudas Lilladher, says the concerns, as regards these stocks, have not been overdone, and suggests that there’s a serious risk of further slowdown in the economy. “Everyone was hoping that there would be some recovery in the second half of the fiscal, which is nowhere in sight. Capital goods stocks are in for a difficult time at least for the next few quarters. One should stay away from this space at least for a couple of quarters,” he says.

Muchhala of Nirmal Bang maintains a ‘sell’ rating on Bhel, Thermax, ABB and Siemens. He has a ‘buy’ rating on Triveni Turbine, Crompton Greaves, KEC International and Power Grid Corp of India Ltd.