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CAPITAL GOODS & POWER
Reflecting the buoyant mood in the economy, the capital goods index,
which is barometer of the growth in the sector has posted decent gains in
the current fiscal. For the month of October 2010, capital goods index rose
22% yoy. With the economic growth rates being revised upwards, the
prospects of Capital Goods sector has definitely improved. However, the
question remains how strong is the capital goods cycle. Management
commentary indicates that order enquiries have been continuously
improving, but we are nowhere closer to the boom in capital goods that
we saw in 2007-08.
Several factors are pulling back the growth of the sector including
increasing delays in project activity due to longer time on land acquisition
and environmental clearance. Sluggish decision making is also stalling the
growth in infrastructure activity. This happens to be the case in road
building and Oil and Gas. Competitive scenario has also increased with
several large orders being placed with the Chinese. In Transmission and
Distribution equipment, availability of unutilized capacity is leading to
margin erosion and higher capital engagement. Another concern is
inflation which has negative implications for sector in terms of slowdown
in investment activity as well as increase in costs. Material prices have also
inched up, which is an important parameter to monitor.
Preview Highlights
n We expect aggregate revenue growth of 17% yoy in the third quarter.
n Aggregate EBITDA is expected to at a slower pace by 12% yoy mainly driven by
reduced margins in ABB, Siemens and BEL.
n Aggregate PAT to remain flattish.
n The business outlook for Capital Goods has improved though it is nowhere
closer to the boom times in FY06-07.
n To profit from the capital goods sector, we recommend investors to follow a
stock specific buying strategy.
n We would recommend selective buying in stocks like L&T, Gujarat Apollo,
Cummins India, Havells India, TIL Votlas, Greaves Cotton, Diamond Power and
Hind Dorr Oliver.
Stock Performance
Among the stocks that outperformed during the quarter, were Greaves Cotton,
Areva, TIL and Thermax. These companies had reported strong set of numbers in
the 2Q which were ahead of expectations. BHEL underperformed despite good
quarterly numbers owing to negative newsflow on intensifying competition in the
power generation equipment space. L&T and Siemens were largely a market performer.
HDO, ABB, Voltas and Blue Star had reported disappointing Q2 numbers
which was one of the reasons for their underperformance. Among other companies,
Crompton has been performing well in Q2 on account of growth in domestic
market whereas concerns remain in international markets. Cummins India reported
robust growth in the engine business. Suzlon continued to remain a
underperformer due to muted order book growth and highly leveraged balance
sheet.
Material price scenario
During the quarter, average price of steel rounds was up 9% yoy to Rs 37500 per
ton. Steel prices are up even on a sequential basis.
Average price of copper which is the prime raw material for electrical equipment
has increased 26% yoy in the quarter. The effect of this would be in terms of
higher revenues but downward pressure on EBITDA margins coupled with increased
inventory.
Forex Scenario
Rupee has been largely stable during the quarter and has fluctuated marginally
against the USD and Euro.
n Suzlon: We expect another set of poor results from Suzlon as the combined
impact of lower up tick in international business and higher interest costs eroding
profitability. Although company has succeeded in increasing its order book
recently in the domestic market and this could be a positive for the company
going ahead. The stock has underperformed the broader market in the past and
order book growth remains a key variable to monitor.
n BHEL: Third quarter numbers should be impressive as robust execution coupled
with margin expansion (led by operating leverage) drives earnings growth. The
stock has been a market underperformer mainly due to indications that growth
in order intake is likely to slow down from current year. BHEL has lost a few
bulk orders to Chinese and private Indian competitors. China-based Dongfang
Electric, for instance, bagged Abhijeet Group's Rs 113 bn order for 600 MW
supercritical units. In another instance, Reliance Power placed orders worth
around Rs 377 bn with Shanghai Electric for coal-fired power generating equipment.
The company's Trichy based boiler mfg operations had delivered 0.5 mn tons in
FY10 and is on track to dispatch 0.68 mn tons and 0.8 mn tons in FY11 and
FY12 respectively.
n ABB: ABB had reported another disappointing set of numbers in Q3 CY10 a reflection
of orders won at very low margins. Euro has depreciated further by 7%
in Q3 CY10 which may mean further losses on forex front. The power transformer
sector is going through margin pressure as players have been undercutting
prices to utilize their capacity.
n Crompton Greaves: CGL should report healthy earnings for the quarter mainly
aided by improved profit margins and lower interest charges. The company is
cash surplus at standalone level and has a minor net debt at consolidated level.
n Siemens: We forecast healthy revenue growth for Siemens as the company has
started the year with a 32% increase in order book. Profits would be lower on
yoy basis as the company had extra-normal margins in the Q1 FY10.
n Areva: The company had come out with good set of numbers in Q3 CY10. We
expect revenue growth of 25% yoy and profit growth of 35% yoy in Q4 CY10.
However, order intake has remained anaemic during the year indicating likely
slowdown in revenues in the future quarters. Increase in price of Copper may
also throw negative surprises on margin front.
n Voltamp: The company's main client base is the non-utility customers and we
expect the ongoing expansion in industrial production to auger well for the
company's business. However, in line with other transformer makers, the company
reported sharply lower EBITDA margins in Q2 FY11 and has guided for
margin pressure for FY11. We expect sharp decline in margins to result in
degrowth in profits.
n Larsen & Toubro: The company had surprised the street with strong execution
in Q2 FY11. We expect healthy revenue growth in Q3 and Q4 thereby enabling
the company to meet its revenue guidance of 20% in FY11. On the order intake
front, the quantum of orders won during the quarter has been on the
lower side. Any signs of a slackening in order intake would be closely watched
by the street.
n Cummins India: We expect further strengthening in domestic market sales on
back of power and industrial segments along with significant YoY improvement
in export sales. Company is likely to maintain its margin at EBITDA and PAT levels.
n Hind Dorr Oliver: The company has been an underperformer in the engineering
universe in FY11 as order backlog has remained stagnant for quite some
time. We expect profit growth to moderate in FY11.
n Thermax: We expect to post excellent revenue and profit growth as the company
had begun the fiscal with a very strong order backlog.
n Voltas: The Voltas stock has underperformed the market on disappointing
numbers and sluggish order intake from Middle East. We expect muted revenue
growth as the Electomechanical project segment has started the year with a flat
order backlog. The company has recently tied-up with a Saudi Arabian company
for entry into the Saudi Arabian market. We expect improvements on the order
intake front when the company reports its Q3 numbers.
n Bharat Electronics: We forecast moderate growth in revenues and profits for
the company. The company has received Rs 25 bn in order intake in the H1
FY11. The company is targeting Rs 70 bn in order intake in H2 FY11. The company
is reported to be in a strong position to win a USD 3.3 bn order for supply
of Akash missles to the IAF.
n Kalpataru Power Transmission KPTL is likely to maintain its margins in
Q3FY11. Company should report decent growth in sales and profits. We would
be closely monitoring the growth in order book which has remained muted in
past two quarters and should be a key variable for stock performance.
n Greaves Cotton: We expect robust profit growth in Q2 FY11 aided by consistently
high margins and healthy 3W volumes.
n Diamond Power Infrastructure (DPIL): We expect DPIL to report impressive
set of numbers for Q3 FY11 aided by ramp-up in its cables capacity. There is
possibility of the company surprising on the upside.
n NTPC: The company's power generation has remained flat during the quarter
which should result in muted profit growth in Q3 FY11.
n AIA Engineering Ltd (AIA): AIA is expected to report robust growth in revenues
as well as profits in Q3. This would mainly be on account of continued up
tick in new market creation in mining space. Cement and power sectors are
expected to report healthy replacement demand for mill internals.
n Gujarat Apollo Limited(GAL): GAL should report muted YoY growth due to
1)higher base of FY10 2) elongated monsoon this year has differed sales to the
succeeding quarters 3) NHAI has slowed down in awarding new projects. We
expect margins to fall slightly on account of increased input prices.
n Tractors India Limited (TIL): TIL nos are not comparable as company has restructures
the Caterpillar business into its fully owned subsidiary TIPL. However
we expect the company to maintain margins and increasing sales trend.
n Havells India Ltd (HIL): HIL is likely to report meaningful growth in revenues
and market share in the domestic business. Sylvania restructuring should
progress in positive direction and is expected to aid to operating margins.
n Everest Kanto: We expect EKC to report growth in revenues on the back of
pick up in demand for CNG cylinders and higher realisations. The operating
margins would be higher on YoY basis as high cost inventory has been liquidated.
n Time Technoplast: We expect strong growth in revenues and profitability of
TTL due to increased contribution from the newer products like high pressure
pipes and prefabricated shelters. Also due to pick up in the industrial activity we
expect increased business from the industrial packaging, battery, healthcare and
infrastructure vertical.
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