High commodity prices may have dented Q3 profitability of capital goods cos

Higher commodity prices, alongside additionally negative sentiment towards the end of the December quarter due to Omicron, are expected to hurt profitability, as well as revenues of domestic capital goods companies, on a year-on-year (YoY) basis, said brokerages.

“Demand witnessed a healthy pick-up in October- November 2021, while December experienced lower growth due to the rising spread of Omicron and increasing Covid caseloads. During the third quarter (Q3) of 2021-22 (FY22), the industry is likely to have witnessed lower volumes due to weak festival season and muted rural demand,” said a Reliance Securities report.

Larsen & Toubro (L&T), Thermax, KEC International, and Siemens, among others, are some of the capital goods companies in the domestic market.

“We expect Thermax's revenue growth momentum to continue and see a 20 per cent YoY rise to Rs 1,693 crore. However, we expect the earnings before interest, tax, depreciation, and amortisation (Ebitda) margin to be under pressure and fall 300 basis points (bps) to 7.5 per cent YoY on account of rising raw material prices,” said a Nirmal Bang report.

KEC International is likely to post revenue of Rs 3,750 crore, up 14 per cent YoY, led by execution of a strong order book. Ebitda margin is likely to fall 160 bps YoY to 7.5 per cent on account of rising commodity costs, which will affect margins in the fixed-price international contracts. “We expect 14.6 per cent YoY decline in net profit at Rs 124 crore,” said the report.

In terms of order inflows, the sector is expected to have witnessed weakness in the period under review.

After a good ordering activity in the first half of FY22 (up more than 20 per cent YoY), order inflows weakened in the first two months of Q3FY22. Inflows were down 20-30 per cent, largely due to significantly high order inflows for high-speed rail last year. Although there were orders in the rail and Metro segments, they were much smaller in size, said Emkay Research.

“L&T has announced orders worth Rs 30,000 crore in the December quarter. It has a 250,000-strong workforce at all sites during the quarter and labour availability was more or less stable. A minor execution impact is expected due to supply-chain bottlenecks and delayed exports during the period,” said a Reliance Securities report.

Overall, order inflows are expected to remain respectable, with some project deferrals across key segments to the fourth quarter of FY22, said ICICI Direct.

Ordering activity has picked up, led by higher government spending in railways, roads, Metro, power transmission/distribution, and oil and gas. Private-sector capital expenditure (capex), on the other hand, was muted and is expected to pick up over the next few quarters, led by various government initiatives, such as the production-linked incentive, said brokerages.

Alongside, the capital goods sector continues to face challenges, such as steep rise in commodity prices, higher transportation costs (both overseas ocean freight and domestic transport), and shortage of imported components due to global shipping challenges. 

Going ahead, recovery in the capex cycle, order inflows, and adverse impact on working capital will be keenly monitored for the capital goods sector, said Nirmal Bang.