Basics back rally in capital goods

Improved execution and better operating levers have helped BHEL, Cummins, Siemens outdo expectations

Capital goods stocks are among the surprise outperformers so far in 2017. While the S&P BSE Sensex has returned a little over eight per cent gain since the start of the year, the stocks of ABB India, Siemens, Cummins India and Bharat Heavy Electricals (BHEL) have outperformed it, with returns of 9-29 per cent.
 
GE T&D (formerly Alstom T&D) has gained by three per cent in this period.
 
While the increasing preference for non-consumer oriented stocks has helped them to perform better, the improving fundamentals as reflected in their recent quarterly earnings (except ABB’s, due on Thursday) indicates the good ride might continue. Four key operational metrics look more positive than a year before.
 
Improving execution: Recovering from a pale 2016 performance, these companies are seeing on-ground progress with projects. Implementation was stretched and unpredictable a year before but is now gathering momentum. In the December quarter, most companies except for GE T&D saw 16-19 per cent growth in revenue; the latter’s was up by 60 per cent, year-on-year.
 
With most ongoing projects being government-backed orders, the companies are positive that execution will only get better in the coming months, given the thrust on infrastructure spending.
 

Better operating levers: As execution improved, the ability of companies to juice out more from existing capacities has also increased. This is reflected in the operating profit margins, with GE T&D putting its plant to highest use in the December quarter (see table). Higher efficiencies helped Siemens and BHEL become profitable at the operational level.
 
As utilisation improves, the hope is that margins should brighten. However, with the current pricing pressure (the bulk of orders come from government tenders, where bids tend to be competitive), unless private participation kicks in, operating margins might remain well below the 2013-14 level of over 15 per cent.
 
That said, a noteworthy shift in favour of high-technology products such as over 756 Kw engines and increased shift towards high voltage direct current projects would be a boon for power equipment players.
 
Order inflows: The government’s ability to award orders is also improving. This has helped GE T&D increase its order book by 38 per cent in the December quarter; Siemens saw five per cent growth. The pipeline also looks promising. While BHEL disappointed on this front with orders flow of only Rs 1,700 crore, it is hopeful that the March quarter would see Rs 15,000 crore.
 
Still, Sunil Mathur, chief executive at Siemens, says he awaits large public tenders in the railways and energy transmission segments. In 2017-18, the companies are confident the government’s rural electrification plans should also boost their order books.
 
Diversification: Having expanded the product offering to suit all ends of the spectrum is working to the advantage of most capital goods companies. In the case of Cummins and Siemens, this has helped them tap opportunities in the railways sector, where the thrust has shifted to upgrading the engine capacities, from the earlier focus of adding of coaches. ABB is also benefiting by supplying transformers to Indian Railways. While BHEL hasn’t seen much progress with rail contracts of late, the company has a proven record on locomotives, engines and electrification.