Nomura: 2011 Update: Electrical equipment- Power play

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Electrical equipment
 Action
We continue to see the opportunity in the sector being driven by power capex, as
we expect industrial capex to revive only modestly and gradually. While competition
and margin pressures will likely increase in the generation space, we expect it to
abate in the T&D space. We highlight Crompton Greaves as our preferred pick in
the space, while we remain bearish on BHEL. We remain positive on Cummins
India, but the stock has significantly outperformed over the past 18M.
 Catalysts
Stronger-than-expected recovery, speedier clearances on land and environment
and early finalisation of key orders will be key triggers for the capital goods stocks.
Anchor themes
Decades of under-investment followed by a march towards building sufficient power
for the nation promises significant opportunities for T&D equipment makers but
rising competition will hurt generation equipment makers.

Power play
 Significant opportunity in the power equipment sector
We believe the Indian electrical equipment sector is poised to benefit from a
strong pipeline of potential order inflows in the power sector over the Twelfth and
Thirteenth Five Year Plans. Of the planned additions in the Eleventh Plan, most
orders have already been placed across the sector, though Twelfth Plan-related
ordering is yet to gain momentum, especially in the transmission and distribution
(T&D) and balance-of-plants (BOP) areas. We also expect a slow but gradual
pick-up in industrial capex momentum that should pave way for growth for other
capex-dependent equipment manufacturers.
 But generation equipment makers are past their peak
BHEL is already benefiting from a record high book-to-bill ratio, which provides
strong visibility on near-term growth. However, we are concerned about market
share losses and margin risks due to growing competition in the sector. Several
new players and the trend of larger developers placing bulk orders with Chinese
companies are bound to exert pressure on sector margins.
 T&D equipment makers likely to see order revival in 2011
While the long-term opportunity for T&D appears robust, near-term order inflow
for the sector has been a concern. While slow order activity from Power Grid was
the main reason, the poor financial health of state utilities also added to the woes.
However, our channel checks suggest Power Grid is likely to pick up order
activity in 2011. We also believe that 2011 could witness increasing privatisation
in the T&D space both at the Central and State levels, which should alleviate
some of the concerns on state spending on T&D capex.
 CRG remains our only BUY in the space; REDUCE BHEL
Stocks for most of the companies in the sector are already pricing in the
anticipated recovery, in our view. However, we highlight those that will likely be
winners over the next 5-7 years rather then just those benefiting on near-term
earnings strength. On this count we continue to like Crompton Greaves (BUY)
and Cummins India (NEUTRAL). We remain bearish on BHEL as we expect
further stock de-rating on concerns over market share, margins and operating
cashflow.