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Patchy capex cycle
India’s capex cycle has remained patchy with new project announcements
falling by 41% YoY (29% QoQ) in 3Q. A modest 3% QoQ increase in projects
under implementation also indicates flagging momentum on project starts.
Delays in land acquisition, environmental and other approvals, inadequate
government support for award of PPP projects and rising interest rates are
key culprits. Power generation projects have been the only bright spot. We
believe road construction and power T&D could also see a pick-up soon. Rising
commodity prices is another headwind for capital good stocks, which have
under-performed recently. We believe BHEL is the best placed in this scenario.
New project announcements show a dip
‰ New project announcements fell by 41% YoY (29% QoQ) in 3QFY11 in value terms.
‰ The trend was broad based, with power, manufacturing and services reporting a decline.
‰ L&T’s 3Q order inflows were Rs134bn, lower than our expectation of c.Rs200bn. This was
due to deferment of projects, which should get awarded in 4QFY11/1QFY12.
‰ Order awards by PowerGrid and NHAI have also been slower than expected, though we
expect them to revive in 4QFY11.
Execution also seems to be lacking pace
‰ Projects under implementation rose by a modest 3% QoQ in 3QFY11; execution ratio
(projects under implementation/ projects announced) continued to hover around 50%.
‰ Electricity is the only sector not to witness a decline in execution starts in 3Q FY11.
Manufacturing, construction and services reported a sharp decline.
‰ With interest rates rising and acquiring land and getting environmental clearances
becoming difficult, execution could remain slow over the next few months. However,
activity should pick up in highway and power T&D sectors.
Rising commodity prices could hurt margins
‰ Commodity prices have increased sharply over the last six months - especially non
ferrous metals (copper up c.40%). Despite capital goods companies hedging some of
their commodity exposure, sharp rise could bring down margins in coming quarters.
‰ Most engineering companies (BHEL, Crompton, ABB) import a large part of their
components from Europe and Euro depreciation will help in offsetting the impact partly.
‰ L&T’s margins in 3Q declined by 155bps YoY to 10.8% in 3Q, on account of some
projects not reaching margin recognition benchmark and higher commodity costs.
Capital goods, EPC stocks have corrected by 4-17% over last month
‰ Capital goods and EPC stocks have fallen by 4-17% over the last month underperforming
Sensex by up to 11%. Infrastructure NBFCs also underperformed.
‰ Given the slow pace of new announcements, order flows of capital goods companies
could disappoint in 3Q, especially for T&D companies (slow PowerGrid awards).
‰ With long cycle order backlog, electricity sub-sector still doing relatively well, half of the
contracts having price escalation clause and less exposure to non-ferrous metals BHEL is
best placed to face the head winds. BHEL is also trading at 1-std deviation below its 5-
year average valuation multiples
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