DeMo, GST blues over, demand revives for capital goods cos

L&T is the preferred pick, but given the opportunities in the power T&D space analysts are also positive on KEC, ABB and Kalpataru

Capital goods companies, which have seen subdued earnings for the past few years, are now seeing green shoots.

Weak private capital expenditure (capex), note ban in November 2016 and implementation of goods and service tax (GST) later in July 2017, had all made the wait longer for investors.

However, things are turning around. The good news is that project awarding is showing improvement and execution is picking up as well.

And these should translate into improved revenue visibility for the companies operating in this sector.

The latest series of orders for Larsen & Toubro (L&T), the Rs 500 crore (Rs 5 billion) EPC (engineering, procurement and construction) co-generation order for Thermax and growing order book of many other companies, point to a better earnings outlook.

The December 2017 quarter (Q3) results already had indicated towards an improvement in the prospects of many companies.

Kunal Sheth and Shreyans Jain at Prabhudas Lilladher had earlier said that Q3FY18 earnings of capital goods sector saw most companies surprise positively on the earnings front, after many quarters of disappointment and downward revision in their profit estimates.

The commentary on future outlook of end-markets such as power T&D (transmission and distribution) led by state electricity boards (SEBs), oil and gas, roads, urban transport (metro), railways, defence and water, etc was also positive with improved pipeline for fresh orders, the analysts added.

Even analysts at Edelweiss Securities said that most companies in their capital goods universe saw execution of projects pickup in Q3, post temporary disruption on back of GST in Q2FY18.

There are additional signs pointing to an improvement. Companies in the sector are already seeing further a rise in orders.

Analysts such as Rupesh Sankhe at Reliance Securities say that there is improvement in many segments as was indicated by January and February IIP number.

Railways, infrastructure (roads and highways) and T&D hold promise, believes Sankhe.

Although private capex may not have shown significant pick up yet and the same will increase only after India Inc’s capacity utilisation levels increase, the government’s allocations are a key driving force.

Among companies, L&T, Sadbhav Engineering, Cummins India, Bharat Electronics and KEC International are preferred picks of Prabhudas Lilladher.

“We continue to like L&T for its sustained focus on balance sheet and profitability (improved working capital cycle and disposal of non-core assets), Bharat Forge due to the pickup in US class 8 truck sales and its plan to build new revenue streams, Bharat Electronics for its unique positioning in high-priority, high-value defence projects and Kalpataru Power on pick up in T&D and railway businesses," say analysts at Edelweiss.

L&T’s presence across the capital goods and infrastructure verticals and enhanced efforts to spur growth and cut debt, are key reasons why the majority on the street are positive on the stock.

Soumen Chatterjee, head of research at Guiness Securities, says that L&T remains to benefit in all its segments and thereby the stock continues trading firm in spite of weakness in broader markets.

The company, during December quarter, had seen a strong revival in execution of domestic projects with its engineering and construction (E&C) segment growing 14 per cent led by infrastructure and engineering sectors.

Order inflows, too, increased 38 per cent year-on-year for the company.

Analysts at Jefferies say that L&T’s return on capital employed (RoCE) and equity (RoE) ratios (key profitability indicators tracked by investors) are on the uptrend and the upside in its stock will be driven by macro tailwinds and balance sheet improvement.

In the power T&D space, KEC International is well placed to benefit from the improving business environment. Sankhe and other analysts expect KEC and Kalpataru Power Transmission to gain from the increasing opportunities in the T&D sector.

ABB, KEC and Kalpataru Power are preferred plays in the T&D and industrial space of Prabhudas Lilladher, while Edelweiss is bullish on Kalpataru, KEC and Techno Electric.

The traction in T&D space, which was earlier driven by orders to expand the country’s power grid assets, is now being provided by state electricity boards.

Moreover, the railways is also spending more on electrification and other projects, which augur well for these companies.

On the flip side, while there are some green shoots in the power generation equipment space too, analysts say that near-term demand environment will remain muted, given the low plant load factor of existing power generation capacities.

Photograph: Mansi Thap;iyal/Reuters