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Capital Goods (Tier I Co’s order inflow robust, capex to
broaden) Positive
Moving into CY11/FY12, all eyes would be on rate of order inflows (for Bhel
inflows are up 20% YoY in H1FY11) for capital goods companies. Given the
buoyant consumption demand in the economy and with the same expected
to remain strong going into CY11, this will require corporates to invest. This
will create opportunities for the capital goods sector. CY10 witnessed
robust order flows from the power generation segment whereas order
inflows from segments like power transmission and process sectors were
tepid. They will pick up in CY11.
⇒ Project announcements (projects worth | 9,50,000 crore have been
announced in H1FY11), better utilisation levels (robust asset turnover
ratios are showing signs of a capex pick-up) and increasing end
product prices will encourage corporates (rising prices of commodities
like copper, coal and crude will call for capex from metals and process
sectors) to invest in capacity creation. This, in turn, will lead to order
flows for capital goods sector.
We expect the industrial segment, power transmission (PowerGrid
about to announce 40% of its committed capex for the Eleventh Plan
in FY11 and FY12) and the power generation equipment (~35% of
Twelfth Plan ordering) segment to contribute to order flows
⇒ Rising commodity prices (especially copper and steel) are going to
impact the operating margins. Companies relying significantly on
working capital may have to deal with high cost of borrowings due to
tight liquidity in the system. This, we believe, will be more crucial for
midcap companies as most big players command a better working
capital cycle. We expect a 60-70 bps fall in the EBITDA margin for our
coverage universe in FY12E
⇒ On the valuations front, large caps are trading at a discount to their
historical average multiples (Bhel is trading at 17.5x its FY12E EPS vs.
its historical one year forward multiple of 21x) and can be looked upon
on declines. On the other hand, midcaps (Hindustan Dorr Oliver) are
trading at relatively low multiples with respect to large caps and their
own historical averages. A rise in order flows will be a key trigger for
multiple expansion of the entire sector. Also, what can be a trigger for
power generation manufacturers is the levy on import of foreign
equipment, which will provide a level playing field and increase the
size of the opportunity. The key beneficiaries would be Bhel, L&T and
Thermax
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