Early signs of recovery for capital goods companies

In February, when most capital goods companies showed improved capacity utilisation, it was seen  as an early sign of turnaround in the sector. That belief has strengthened, thanks to a strong March quarter performance by ABB India and Siemens India. Even as their net profits took a hit due to changes in accounting norms, the key takeaway was eye-grabbing growth in order inflows. For ABB India, the 28 per cent year-on-year growth in order inflows came from the power transmission and distribution (T&D) segment, while pockets such as renewable energy and railways also supported it. Similarly case entails for Siemens India. The spike in order inflow (up 61 per cent year-on-year) in the March quarter has been fuelled by the cement, steel, and automotive (construction equipment) sectors as modernisation, maintenance and expansion are underway in these industries. 

This has led analysts to believe that these could be early signs of turnaround in capacity expansion (capex) by India Inc. Edelweiss in a note dated May 15 says that the recovery in capex is pretty broad. 

However, unlike the previous cycle, which was helped by power generation, roads, metals, and other infrastructure projects, the current leg of capex recovery encompasses sectors such as railways, oil and gas, defence, and power T&D. 

For the railways sector, planned capex of nearly Rs 8,56,000 crore — almost twice the capex planned in 2000-15 — is extremely positive. At this pace, Edelweiss affirms that the rail investments will far outstrip those in national highways over the next decade. 

Sectors such as defence and power T&D, where efforts are underway to plug the existing systemic gaps, strengthen capabilities and open the sector to healthier private participation. For oil and gas, changes in emission norms, forcing the refineries to adopt the BS-VI standards ahead of their implementation in 2020, are a big capex kicker.

“We favour industry leaders that are best-placed to ride the ongoing PSU capex and emerge prime beneficiaries of private capex pick-up, whenever it happens,” Edelweiss adds. 

Analysts at SBI Cap Securities concur with Edelweiss. They say that unlike the earlier capex cycle, which saw high participation from the private sector, the role and dependence on government spending may be high in the current cycle. “Capex would largely be driven by the government in the medium term. The emergence of private sector capex is still some time away due to a high number of shelved projects, low capacity utilisation in key end-user sectors and leveraged balance sheet,” says SBI Cap.

These point to a much-needed pick-up in the capital goods sector. However, investors have to prepare for volatility in profitability. The March quarter results of ABB and Siemens indicated that due to a higher share of short-cycle orders (with execution tenures of 12 months or less) operating margins took a hit of 100-200 basis points. This compression is likely to stay, given the changing dynamics of order inflows. Results from Cummins India (May 18) and L&T (May 29) should give more clarity on this front. For now, analysts prefer stocks such as ABB India, Cummins India, Bharat Forge, L&T, Bharat Electronics, and Engineers India.