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Glimmer of hope
While capital goods makers are seeing a revival in demand, it still may be a little too early for investors to join the party

Prathamesh Mulye

While a volatile market is the new normal as we enter the election season, it brings good tidings for sectors directly related to the economy. In a bid to accelerate growth and create jobs, the government is pumping a lot of money into the infrastructure sector. And one of the biggest beneficiaries of the government’s infrastructure thrust is the capital goods sector, which is finally showing signs of a rebound.

As the demand for heavy equipment increases, a precursor for pickup in business activity, capital goods maker Siemens India, ABB India, Thermax and Cummins Indiawere able to beat sales and operating income estimates in the quarter ended September 2018.  According to Jefferies report, the capital goods makers reported the strongest growth in 28 quarters. “Our coverage universe saw 20% YoY revenue growth after 27 quarters of the sluggish trend. The EBITDA margins and order flows during the first half of FY18 touched a five-year high,” says Lavina Quadros of Jefferies. 

In fact, the order flows are even better than the period when the Modi-led government came to power in May 2014. While orders grew by only 6% CAGR between FY14 and FY18, things rebounded sharply in 1HFY19. Even excluding BHEL, which has seen its orders more than double in 1HFY19, order flow still was up 32% YoY  during the first half of FY19.

Analysts believe that the growth will sustain for at least two more quarters. “We expect Q3 numbers to be similar to how Q2 was and Q4 is generally the best quarter for the sector,” says Harshit Kapadia from Elara Securities.

Cash is king

With the government investing in roads, railways and smart cities, analysts are banking on ABB India, Siemens India, Cummins India and Thermax to capitalise on rebound in the investment cycle. “The companies which are debt-free and have relatively good cash flow will be able to execute a large chunk of these orders resulting in higher revenue growth and stable margins,” says Kapadia.

 ABB India, Cummins India, Siemens, and Thermax had a cash flow of 14.19 billion, 4.90 billion, 36.45 billion and 4.13 billion as of March 2018. While ABB India and Siemens are debt-free, Cummins India and Thermax have a debt to equity ratio of only 0.06x and 0.09x respectively.

Private pick up

Not only is the government pump priming the economy, even private investments are showing signs of revival. “Investment cycle continues to strengthen and presents one of the best pictures in a long time, suggesting a strong pick-up in private industrial investments even if eye-grabbing large-scale projects are yet to start,” says Lokesh Garg of Credit Suisse in the report. The core sector data further vindicates analysts’ observations. Capital goods output has risen 7.3% (YoY) in the first half of FY19 compared with a 0.3% in 2017-18.

Even the demand for imports seems to be on the uptick, after five weak years (FY12-17), capital goods imports grew strongly at 20% in FY18 and further by 26% in the first six months of FY19, points out the Credit Suisse report. “Capital goods imports are fairly large (US$60-70 billon). The growth has been broad-based with higher demand for metal products, electrical and non-electrical industrial machinery,” says Garg.

But growth is likely to bring in a lot more competition with companies trying to outbid each other to win projects and improve their capacity utilisation. Jefferies’ Quadros says that it is best to wait for two to three quarters to determine whether the entire sector is back on the growth path. It doesn’t help that the valuations aren’t cheap either. ABB India, Cummins India, Siemens India, and Thermax are currently trading at PE of 46x, 24x, 28x and 37x on a one-year forward basis. But for the sector that has had its fair share of challenges for more than five years, this is the first glimmer of hope. And for now, they are not complaining.  As for the investors, it may be too soon to open the bubbly just yet. 

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