Order inflows rise but future remains tense

Sales and profit growth under pressure on weak demand

The fourth quarter has not been as bad for the capital goods sector, as the Street had expected. Even though factory output has grown at an anaemic one per cent through 2012-13, the silver lining for the sector has been order inflows. Larsen & Toubro (L&T), the largest player in the engineering and capital goods space, is not the only one to clock a 25 per cent growth in order inflows in FY13; others have also seen a pick-up in fresh orders, especially in the fourth quarter.

Bharat Heavy Electricals Ltd (Bhel) reported a 205 per cent growth in order inflows to Rs 20, 800 crore during the fourth quarter compared to Rs 10, 700 crore during the first nine months of the fiscal. The story is similar for others like Thermax, which reported a 43 per cent year-on-year (y-o-y) pick-up in order inflows during the quarter to Rs 1,150 crore. After struggling with operational issues for two years, Crompton Greaves has reported a 32 per cent sequential increase in order inflows in Q4 at Rs 2,983 crore.

Analysts are happy but are still not sure whether the trend will continue. Revenue growth remains a huge challenge as order cancellations and working capital days stress are bigger concerns. Given that the investment cycle has come to a standstill and there is no clarity on when the sector will revive, revenue growth estimates for most of these companies are muted for FY14. L&T Chairman AM Naik told analysts that challenges in the economy persist in the form of infrastructure bottlenecks, resource availability, high fiscal and current account deficits.

Also, since reforms are not yet impacting projects on the ground, this has affected the investment climate. Morgan Stanley has for long been calling for a margin, marketshare and multiple derating of Bhel for similar reasons.

According to the brokerage: "Adjusted for the backdrop of the weak revenue performance in Q4FY12 and hence the low base, revenue growth was even more disappointing, with the company registering the worst y-o-y growth on a quarterly basis in the last 10 years." The story remains the same for other capital goods players, too, as there would be intense competition for the handful of power sector orders from the private and public sector companies, going forward.

Analysts say order cancellations are a big concern. L&T reported it in the fourth quarter and Bhel has been seeing it for some time now. Thermax has reported a y-o-y decline of 13 per cent in sales during the fourth quarter and there is no immediate trigger for an improvement for the sector as a whole. The company reported a decline of 12 per cent in sales for the full year and the order book declined 25 per cent y-o-y to Rs 4,830 crore. Misal Singh of Religare Institutional Research says the worst may be over, but there is still no sign of a recovery.

Though the broad perception is that margins have bottomed out and that the fall in raw material costs would come to the rescue, competitive intensity will keep the pressure on margins. Margins in the fourth quarter have continued to decline, despite falling raw material costs. Analysts believe that even though stocks of capital goods companies have underperformed for two years, a recovery isn't likely anytime soon.