Stay selective in capital goods as sector faces slow growth environment

One of the disappointing aspects of the Budget was the tightening of allocations to the infrastructure sector.

 

Revised estimates for FY25 have mostly been reduced from the initial budgetary estimates for FY25. Otherwise, the FY26 Budget would have been flat in terms of overall government capex (there was a 10 per cent nominal growth over revised estimates).

 

In the absence of private investment picking up, lower or flat government spending will impact construction adversely with negative knock-on effects for the cement and steel industry, among others. Capital goods is also likely to see an environment of slow growth. There was less activity and fewer project awards in roads, railways and water sectors in FY25.

 

In roads, hopes for FY26 are pinned on public-private partnerships (PPPs) (HAM and BOT modes) with allocation up only 2.4 per cent which translates to a drop after inflation.

 

Railway allocations are flat but metro projects have higher allocations and there is focus on procurement of wagons and coaches.

 

Housing and urban development has seen substantial allocation increase, which may compensate to some extent for the slowdown in roads.

 

Defence capex allocations are ahead of inflation at 13 per cent growth and the aerospace/space budget is also up. It would be prudent to be selective for the capital goods sector, since government order inflows will be low.

 

Investors should focus on companies which are less dependent on government capex.

 

In general, there will be valuation downgrades across the sector, due to lower government capex and low expectations for a pickup in private capex. 

 

If the new asset monetisation plan for 2025-30 does succeed in ploughing back capital quickly (the five-year target is Rs 10 trillion), that may lead to increased road activity.

 

The long-term thesis on capex in power transmission and distribution (T&D), renewables, defence, data centres, electronics, semiconductors, production-linked incentives (PLI)-led capex, and battery storage is still valid.

 

But timelines will be extended given lower capex growth for FY26.

 

Companies with high exposure to railways, water, road construction, and generic private capex are more at risk to lower order inflows.

 

Those with a focus on power T&D, renewables, defence, data centres, PLI and aerospace, among others, are better placed.

 

In other positives, shipbuilding clusters will be facilitated to increase the range, categories, and capacities of ships.

 

The Shipbuilding Financial Assistance Policy will be revamped to address cost disadvantages.

 

Power sector reforms should create incentives for electricity distribution and augmentation of intra-state transmission capacity.

 

Spending on Jal Jeevan Mission was limited in FY25 and it has a higher allocation of Rs 67,000 crore for FY26.

 

Capital goods and infra-related stocks saw selling on Monday.

 

Here are brief perspectives on some of the key players in this space.

 

L&T may see lower order inflows on the government front but it is well-diversified across sectors and it has an export profile and its existing order book gives visibility of earnings.

 

ABB is better-placed than most due to its focus on data centres, renewables, and electronics. However, ABB is very highly valued and may see valuation downgrades.

 

Siemens is also highly valued and may see valuation downgrades. It has exposure to the railways segment. Hitachi Energy also has railways exposure and is highly valued but it has a presence in power T&D, which should do well.

 

Bharat Electronics is a key defence player and allocations for defence capex indicate growth prospects are strong.

 

Thermax is heavily dependent on a pickup in private capex which is not yet visible. Cummins also has exposure to some areas where growth should be good. Triveni Turbines has a strong export profile which may be a good hedge.