DEMAND REVIVALIN SIGHT FOR CAPITAL GOODS FIRMS
L&T is preferred pick; analysts also positive on KEC, ABB, Kalpataru
Capital goods companies, which have witnessed subdued earnings for the past few years, are now seeing signs of recovery.
The wait had got longer for investors because of weak private capital expenditure, demonetisation and implementation of the goods and services tax (GST).
The good news now is that project awarding is improving and the pace of execution is picking up. These should translate to better revenue visibility.
The latest series of orders for Larsen & Toubro (L&T), the ~5-billion EPC (engineering, procurement and construction) co-generation order for Thermax, and a growing order book of other companies point to an improved earnings outlook. The December 2017 quarter (Q3) results had indicated better prospects of many companies.
Kunal Sheth and Shreyans Jain at brokerage Prabhudas Lilladher had said Q3 financials of the capital goods sector showed that several firms did better-than-expected on the earnings front, following a few quarters of disappointment and downward revision in profit estimates.
The commentary on outlook for end-markets such as power transmission and distribution (T&D) led by state electricity boards (SEBs), oil and gas, roads, urban transport (Metro rail), railways, defence, and water was also positive, on the back of an improved pipeline of orders, the analysts said.
Analysts at Edelweiss Securities said most capital goods firms saw faster execution of projects in Q3, after a temporary GST-related disruption in Q2 FY18.
Another positive is that companies in the sector are witnessing a rise in orders.
Analysts such as Rupesh Sankhe at Reliance Securities said there was an improvement in many segments, as was indicated by the January and February IIP (index of industrial production) number. Railways, infrastructure (roads and highways), and T&D hold promise, Sankhe added.
Although private capital expenditure may not have shown a significant pick-up yet, and will increase only after India Inc’s capacity utilisation levels move north, the government’s allocations are a driving force.
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 an increase in US Class-8 truck sales and its plan to build new revenue streams, Bharat Electronics for its unique positioning in high-priority, highvalue defence projects and Kalpataru Power on a pick-up in its T&D and railway businesses,” said 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 Street is positive on the stock.
Soumen Chatterjee, head of
research at Guiness Securities, said L&T is likely to benefit in all segments and thereby the stock continues to trade firm, despite weakness in broader markets. During the December quarter, the company had seen strong revival in execution of domestic projects. Its engineering and construction (E&C) segment grew 14 per cent, led by the infrastructure and engineering sectors. Order inflows increased 38 per cent year-on-year.
Analysts at Jefferies said L&T’s return on capital employed and return on equity ratios (key profitability indicators tracked by investors) were on an uptrend and the upside in its stock would be driven by macro tailwind 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 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.
Traction in the T&D space, earlier driven by orders to expand the country’s power grid assets, is now being provided by state electricity boards. The railways is also spending more on electrification, auguring well for these companies.
On the flip side, analysts said the near-term demand environment in power generation equipment would remain muted, given the low plant load factor of existing power generation companies.