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Industrial capex revival continues to elude: Our bottom-up analysis of
capex plans of 30 companies/70 projects, which account for over US$18 bn
of annual capex in India, suggests a continued capex slowdown in FY12.
Order pipelines for cement (oversupply issues, weak demand), metals
(strong plans but slow approvals) and oil & gas (flattish spend in E&P with
steep competition, YoY decline in refining, gas supply impacting pipeline
capex) do not appear strong enough to create a new cycle, in our view
■
Balance sheet healthy, approvals key: While the ability to spend is not the
key concern, as balance sheets (leverage) are in much better shape than in
the previous downturn (based on aggregation of around 100 companies),
our project tracker suggests that around 70% of the projects in this cycle are
greenfield expansions (versus around 30% in the previous cycle), which
slows order activity, as it becomes more dependant on various approvals
and land acquisition challenges
■
End-markets weak, reforms critical: Our end-market analysis suggests
that power/infra cycle should remain weak in FY12 (some acceleration in
ports/roads spend but airport/metro/railway spend muted). Without reforms
(increasing penetration of private vendors in defence/rail orders, retail FDI,
streamlining approval process, vendor qualifications), these end-markets
could remain weak
■
Order inflows could disappoint, underweight capital goods: Given a
weak cycle, we see a risk to our inflow estimates (around 25% for FY12E)
for the sectors, and with margins peaking, room for a rerating is less. We are
therefore now cautious on infra/industrial cycle (companies with high
exposure include L&T (Restricted), reiterate UNDERPERFORM on Punj
Lloyd ABB, Siemens). We remain cautious on the power cycle (NEUTRAL
BHEL/BGR Energy). Havells, Crompton Greaves, KEC and Cummins are
our key OUTPERFORM ideas on account of exposure to global growth.
Industrial capex: No cycle without
reforms
We expect industrial capex to remain weak in FY12, based on our analysis of 70 projects
and capex plans of over 30 companies, which account for over US$18 bn p.a. of industrial
capex in India. Our analysis of project activity in the infrastructure sector does not indicate
any signs of a strong cycle in FY12. Street has been anticipating a recovery and building
in higher inflows for FY12. We see risk to those estimates (CS estimates ~ 25% YoY
growth) and believe that a rerating of the sector might be difficult.
Industrial capex revival continues to elude
The three key sectors (oil & gas, steel and cement) dictate over 70% of the industrial
orders for Indian E&C firm. Our study of the capex plans of 30 companies across these
sectors and 70 projects makes us conclude that capex growth could remain challenging in
FY12, given: (1) the oversupply in cement, (2) flattish E&P spend and high competition
from foreign vendors, (3) that the bulk of refining orders are already awarded, (4) the gas
supply constraints affecting the pipeline capex and (5) the approval/resource bottlenecks
for large projects in steel despite the promising plans. Compared to the previous downturn,
balance sheets are in a much better shape this time (based on aggregating over 100
companies), but over 70% of the projects in this cycle are in the greenfield mode, (versus
30% in the past cycle), making capex more dependant on various approvals and land
acquisition challenges.
End-markets weak, reforms critical
Industrial capex lags the recovery in power and infra cycle, as order momentum in these
segments dictates demand for commodities, which impacts capex. We expect power and
infra cycle to remain weak in FY12. Power equipment order cycle is expected to
decelerate, with: (1) bulk of 12th plan orders having been awarded (please see note dated
20 September 2010, reduce exposure to power sector), (2) weak SEB finances affecting
merchant pricing and future capex, and (3) coal constraints affecting the pace of orders
and execution. On the infra front, our analysis of potential orders in the five sub-segments
suggests a mixed picture. While ordering in roads and ports could accelerate, we expect a
slower growth in metro/railways and airport orders to affect capex growth. Furthermore, we
believe for a sustained capex cycle to emerge, broadbased reforms and creation of new
demand drivers are needed. These include private sector ordering by Railways and
Defence, allowing FDI in retail (among others), streamlining process for land
acquisition/other approvals and a change in the ordering process (related to vendor
qualification, etc.).
Order inflow could disappoint, underweight sector
Street’s sector estimates build in over 25% inflow CAGR until FY13 (based on earnings
estimates), which we believe are at risk, given a likely weak capex cycle. While earnings
estimates for the sector have been cut by 8-10% YTD, more than the earnings risk, we
see risk of order inflow disappointments, and expect the sector to underperform the broad
markets in FY12. Given our cautious view on the power cycle, we retain our NEUTRAL
rating on BHEL and BGR Energy. While we expect the infrastructure and industrial capex
cycle to improve at some point in the future, we remain concerned about the medium-term
performance of the sector. Companies with higher exposure to industrial and infrastructure
capex, include L&T (Restricted), Siemens (Underperform), ABB (Underperform) and Punj
Lloyd (Underperform). Other stocks with a high exposure include Voltas and Thermax
(Both OUTPERFORM, but our order estimates/target prices have been cut). Our key
OUTPERFORM ideas (Crompton Greaves, KEC, Havells and Cummins) in this sector
remain centred on stocks that either sport relatively favourable valuations/lesser earnings
risks or those with high exposure to global growth.
Industrial capex revival continues to
elude
The three key sectors (oil & gas, steel and cement) dictate over 70% of the industrial
orders for Indian E&C firms. Our study of the capex plans of 30 companies across these
sectors and 70 projects makes us conclude that capex growth could remain challenging in
FY12, given: (1) the oversupply in cement, (2) flattish E&P spend and high competition
from foreign vendors, (3) that the bulk of refining orders are already awarded, (4) the gas
supply constraints affecting the pipeline capex and (5) the approval/resource bottlenecks
for large projects in steel despite the promising plans. Compared to the previous downturn,
balance sheets are in a much better shape this time (based on aggregating over 100
companies), but over 70% of the projects in this cycle are in the greenfield mode, (versus
30% in the past cycle), making capex more dependant on various approvals and land
acquisition challenges.
One sector alone cannot create a cycle
Industrial capex spend, in our view, aggregates to over US$80-100 bn over a five-year
plan, with bulk of the capex stemming from four industries: cement, steel, oil & gas
E&P/refining and automobile, of which the first three are critical drivers of orders for Indian
equipment firms. Past trends suggest that capex in these sectors typically have a strong
correlation with each other, which is what creates cycles.
Ability to fund not a concern
Our bottom-up aggregation of cash flows and leverage of over 100 companies across
these sectors suggests that operating cash generation for corporates although strong has
not seen much growth in the past two years, and this probably explains the demand side
moderation (not much margin improvement), which led to slower capex growth in the
economy.
Land and approvals more critical in this cycle
Our analysis of project level activity in the cement and steel sectors since FY03 suggests
that it was much easier for plans to translate into orders in the previous cycle, as bulk of
the orders were through brownfield expansion.
The current cycle has several projects that are being planned through the greenfield mode
and hence have longer approval cycles. There are projects which were conceptualised a
few years back but are awaiting environmental approvals or facing land acquisition issues.
We believe that these delays disrupt the capex flow in a cycle and make it more volatile
and difficult to predict
End-market weak; reforms critical
Industrial capex lags a recovery in the power and infra cycle, as order momentum in these
segments dictates demand for commodities which impacts capex. We expect the power
and infra cycle to remain weak in FY12. The Power equipment order cycle is expected to
decelerate due to: (1) bulk of 12th plan orders having been awarded (please see note
dated 20th Sep 2010, reduce exposure to power sector) (2) weak SEB finances impacting
merchant pricing and future capex and (3) coal constraints impacting the pace of orders
and execution. On the infra front, our analysis of potential orders in the five sub-segments
suggests a mixed picture. While ordering in roads and ports could potentially accelerate,
we expect slower growth in metro/railways and airport orders to impact capex growth.
Further, we believe that for a sustained capex cycle to emerge requires broad-based
reforms and creation of new demand drivers. These include private sector ordering by
railways and defence, allowing FDI in retail, among others, and streamlining the process of
land acquisition/other approvals and a change in ordering process (related to vendor
qualification, among other things).
Macro is important
Spend is primarily dictated by GDP growth and investment intensity and, in that respect,
Credit Suisse expects GDP growth to moderate in FY12, raising questions on the
sustenance of some recovery in capex in FY11. Investment intensity, on the other hand,
can be dictated by reforms alone. The key reason for emergence of a large investment
cycle in India from FY04-05 was the reforms in the power sector that were initiated in
FY03. Further, a new wave of investments in infrastructure emerged with the success of
the PPP format in roads and airports. Strength in power and infra capex increased
demand for commodities triggering industrial capex and, more importantly, the length of
the investment cycle was large given that it came on the back of several years of
underspending. Hence, what is required for a new cycle to form in India, is opening up of
new sectors for private participation and reforms in the approval process (including land
acquisition).
Order inflow could disappoint;
UNDERWEIGHT sector
Street’s sector estimates build in over 25% inflows CAGR until FY13 (based on earnings
estimates), which are at risk given a likely weak capex cycle. While year-to-date earnings
estimates for the sector have been moderated by 8-10%, more than earnings risk, we see
more risk from order inflow disappointments. Hence we expect the sector to underperform
broad markets in FY12. Given our cautious view on the power cycle, we maintain our
NEUTRAL rating on BHEL and BGR Energy. While we expect the infrastructure and
industrial capex cycle to improve at some point in future, we remain concerned about the
medium-term fortunes of the sector. Companies with a high degree of exposure to
industrial and infrastructure capex include L&T(Restricted), Siemens (UNDERPERFORM),
ABB (UNDERPERFORM) and Punj Lloyd (UNDERPERFORM). Other stocks with high
exposure include Voltas and Thermax (both OUTPERFORM rated, but our order
estimates/target prices have been cut in prior reports). Our key OUTPERFORM ideas
(Crompton Greaves, KEC, Havells and Cummins) in this sector remain centred on stocks
that either sport relatively favourable valuations/lesser earnings risks or those with high
exposure to global growth.
Orders inflow expectations builds in a recovery
Our sector order inflow estimates point to an ~25% growth in sector inflows in FY12 and
build in a view of recovery. We believe that consensus estimates are pricing in similar
growth for FY12. Lacklustre order activity could cap multiples for the sector
Rerating unlikely without broad-based reforms
Sector valuations have corrected, but at a forward P/E of 18x, prices in strong growth
expectations in the medium term. Given the risk to sector inflows, we believe the case for
a rerating is not evident.
L&T (Restricted)
Over 60% of inflows for L&T depend on infra and industrial capex. Post the Dec quarter
results, management had highlighted that delays in large order finalisations could impact
their FY11 order inflow guidance that stands at 25% YoY. Since then, while the Rs150 bn
worth Hyderabad metro has been financially closed (Early April), the NTPC bulk tender for
boilers (11X660 MW) has been delayed as one of the bidders is contesting a
disqualification in the Supreme Court. Delay in finalisation of this tender implies that
NTPC’s Rs200 bn tender for 9X800 MW sets could also get delayed. L&T reports on 19
May, and management comments suggest that order traction at the current time (tender
activity) is relatively better than that in the last year. Guidance for the next year is expected
during the announcement of March quarter results.
Siemens (maintain UNDERPERFORM)
Siemens derives over 45% of its revenue from industrial orders. The company has
witnessed some improvement in the short cycle industrial product orders last year;
however, orders from the industrial projects division were muted. Within the projects
segment, Siemens has strong capabilities in the Metals sector, and some order traction is
anticipated for that segment this year. However, with other segments on both industrial
and infra front not expected to do well, it might be difficult for Siemens to achieve street’s
high growth numbers. The stock is pricing in over 20% growth in order inflows p.a. in the
medium term, which we believe could be difficult to achieve.
The ongoing open offer (Siemens AG (that owns 55.2%) has announced an open offer to
buy ~20% of outstanding shares at Rs930/share) has supported the stock over the past
few months. We expect the stock to track fundamentals post completion of the offer on 13
April. We recently downgraded the stock to an UNDERPERFORM (note dated 31 March,
Power T&D: Chinese competition intensifies), and we reiterate our view given the risks to
growth.
ABB (maintain UNDERPERFORM)
ABB has over 40% exposure to industrial ordering, where we continue to see risk for ABB.
ABB’s order inflows declined over 35% in CY10, and our view of order inflows at levels
similar to those in CY08 could be at risk. Our view of recovery in order inflows was based
on ABB’s win in a large HVDC order as well as recovery in the T&D order cycle and the
benefits from the new domestic manufacturing/JV clauses. With ABB India’s portion of the
US$1 bn order being only about 15% of the order and competition increasing in the T&D
space, our estimates are at risk, in our view. Our earnings numbers are, however, at the
bottom of street’s estimates. Hence, we maintain an UNDERPERFORM rating on the
stock.
Punj Lloyd (maintain UNDERPERFORM)
Our concerns on Punj Lloyd are largely centred around weak execution in the past,
several pending claims in international subsidiary on past projects and high leverage.
While Punj Lloyd’s order book of Rs280 bn (as of Dec 10—includes Libya orders) was up
19% YoY, revenue growth in the first 9M has declined 35% YoY, largely due to nonmoving
orders in Libya. While management has now removed US$1 bn worth of projects
(in Libya) from the order backlog, we note that there is risk with regards to execution of the
remaining orders (~US$800 mn). Since Punj Lloyd had received advances on the orders
booked under PLL, management highlighted that net of costs, the company was cash
positive on these contracts.
Apart from the concerns around execution of projects in Libya as well as ability to improve
order traction from such geographies in future, auditors have also qualified Rs2.4 bn for
non-provisioning in the ONGC project and Rs655 mn for LDs. The Ensus project is
currently going through a warranty period, and hence Ensus continues to retain £7.7 mn of
retention money and £2.2 mn of guarantees. In the SABIC project, £18 mn of claims by
various subcontractors are still under dispute. Management expects favourable awards in
some of these contracts. We believe that consensus numbers for Punj Lloyd are at risk
and hence maintain our UNDERPERFORM rating on the stock.
Key OUTPERFORM ideas
Crompton Greaves (maintain OUTPERFORM)
Over 40% of inflows for CGL stem from their international business where order traction is
improving. In addition, CGL has very limited exposure to industrial and infra sectors. The
domestic T&D business, which accounts for over 35% of sales, is witnessing heightened
competitive activity, especially in high voltage orders; however, we expect CGL to maintain
market share given a better cost structure than peers and entry into the 765 KV substation
segment. We maintain our OUTPERFORM rating on CGL as it overtrades at a steep
discount to sector valuations (32%) despite a relatively better earnings track record.
Havells (maintain OUTPERFORM)
We remain positive on Havells on account of recovery (stabilisation) of performance at its
International subsidiary, Sylvania (accounts for 50% of revenues for Havells). Increasing
mix of consumer business is also a positive, in our view, as a higher exposure to branded
products business (by launching four products—mixer/grinder/juicer, toaster, iron, hand
blender) shields the company from pricing pressures and also helps outgrow competition
by gaining share at the expense of the unorganised market. Our recent interaction with
management also indicated a positive outlook from the company. On the domestic front,
management hoped to achieve 18-20% sales growth, with 11.5% EBITDA margins in
FY11, with margins to sustain next year, led by pricing actions. Sylvania is also tracking to
achieve over 8% margins next year. Attempts to increase mix of fixtures (high margins):
lamps, increase in mix of emerging markets are key drivers. Europe is expected to have
flat revenue next year, but stronger growth in LATAM and product introductions in new
geographies such as India should help improve revenue growth. Maintain OUTPERFORM.
Cummins (maintain OUTPERFORM)
Cummins has over 30% exposure to exports where order traction appears strong.
Cummins Inc. has also decided to use India as a base for low KVA engines for exports to
Asia and Africa, and this should help support growth rates for exports in the coming years.
In terms of domestic business, management appeared positive on demand and
highlighted that the company’s new mid-range capacity allocation from Tata Cummins will
also get fully utilised by the next year. Margins remain a key area of uncertainty (and a risk)
as impact of commodity costs will now start reflecting in costs; however, price hikes are
yet to be taken. While Cummins also gets impacted by weak industrial and infra activity,
what sets it apart from most other industrial equipment firms is the dominance of its
product portfolio and diversified end-market exposure even within the industrial segment.
We maintain our OUTPERFORM rating on Cummins.
KEC international (maintain OUTPERFORM)
We retain our positive view on KEC international given its high exposure to international
orders (over 55%), which shield the company from steep competitive activity in the T&D
sector in India. KEC has also gained qualifications in the substation EPC segment,
including the HV segment. Powergrids relaxed criterion for substation EPC orders should
help KEC win orders next year, in our view. KEC also benefits from a potential recovery in
railway segment ordering in the coming years—although we do not build in significant
orders from the rail segment in FY12.
Removed from our key stock ideas
We remove both Thermax and Voltas from our key stocks lists, given their exposure to
industrial/infra capex, although we maintain an OUTPERFORM rating on both. Over the
past three months, we have reduced our order estimates and target prices for both stocks
to reflect that view. (On Voltas please refer note dated 3 Feb, Voltas: PAT below estimates;
Moderating expectations to reflect weak near term, and on Thermax please refer note
dated 16 March, Thermax: Order loss to Cethar Vessels; low visibility on utility order wins
to impact valuations).
However, we maintain our OUTPERFORM rating on Voltas on account of favourable
valuations relative to the sector, strong balance sheet and high exposure to capex in the
Middle East (order pipeline in geographies such as Saudi Arabia, Qatar is very strong, as
per management comments).
On thermax, we maintain our Outperform stance largely due its entry into utility scale
orders. While order traction for Thermax has been much slower than peers, in this
segment, we note that a strong balance sheet, good management capabilities, strong
execution capabilities and presence of a strong technology partner should enable
Thermax to drive significant traction in inflows in the next few years. That said, we do not
see any major traction in inflows in the next few quarters.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
■
Industrial capex revival continues to elude: Our bottom-up analysis of
capex plans of 30 companies/70 projects, which account for over US$18 bn
of annual capex in India, suggests a continued capex slowdown in FY12.
Order pipelines for cement (oversupply issues, weak demand), metals
(strong plans but slow approvals) and oil & gas (flattish spend in E&P with
steep competition, YoY decline in refining, gas supply impacting pipeline
capex) do not appear strong enough to create a new cycle, in our view
■
Balance sheet healthy, approvals key: While the ability to spend is not the
key concern, as balance sheets (leverage) are in much better shape than in
the previous downturn (based on aggregation of around 100 companies),
our project tracker suggests that around 70% of the projects in this cycle are
greenfield expansions (versus around 30% in the previous cycle), which
slows order activity, as it becomes more dependant on various approvals
and land acquisition challenges
■
End-markets weak, reforms critical: Our end-market analysis suggests
that power/infra cycle should remain weak in FY12 (some acceleration in
ports/roads spend but airport/metro/railway spend muted). Without reforms
(increasing penetration of private vendors in defence/rail orders, retail FDI,
streamlining approval process, vendor qualifications), these end-markets
could remain weak
■
Order inflows could disappoint, underweight capital goods: Given a
weak cycle, we see a risk to our inflow estimates (around 25% for FY12E)
for the sectors, and with margins peaking, room for a rerating is less. We are
therefore now cautious on infra/industrial cycle (companies with high
exposure include L&T (Restricted), reiterate UNDERPERFORM on Punj
Lloyd ABB, Siemens). We remain cautious on the power cycle (NEUTRAL
BHEL/BGR Energy). Havells, Crompton Greaves, KEC and Cummins are
our key OUTPERFORM ideas on account of exposure to global growth.
Industrial capex: No cycle without
reforms
We expect industrial capex to remain weak in FY12, based on our analysis of 70 projects
and capex plans of over 30 companies, which account for over US$18 bn p.a. of industrial
capex in India. Our analysis of project activity in the infrastructure sector does not indicate
any signs of a strong cycle in FY12. Street has been anticipating a recovery and building
in higher inflows for FY12. We see risk to those estimates (CS estimates ~ 25% YoY
growth) and believe that a rerating of the sector might be difficult.
Industrial capex revival continues to elude
The three key sectors (oil & gas, steel and cement) dictate over 70% of the industrial
orders for Indian E&C firm. Our study of the capex plans of 30 companies across these
sectors and 70 projects makes us conclude that capex growth could remain challenging in
FY12, given: (1) the oversupply in cement, (2) flattish E&P spend and high competition
from foreign vendors, (3) that the bulk of refining orders are already awarded, (4) the gas
supply constraints affecting the pipeline capex and (5) the approval/resource bottlenecks
for large projects in steel despite the promising plans. Compared to the previous downturn,
balance sheets are in a much better shape this time (based on aggregating over 100
companies), but over 70% of the projects in this cycle are in the greenfield mode, (versus
30% in the past cycle), making capex more dependant on various approvals and land
acquisition challenges.
End-markets weak, reforms critical
Industrial capex lags the recovery in power and infra cycle, as order momentum in these
segments dictates demand for commodities, which impacts capex. We expect power and
infra cycle to remain weak in FY12. Power equipment order cycle is expected to
decelerate, with: (1) bulk of 12th plan orders having been awarded (please see note dated
20 September 2010, reduce exposure to power sector), (2) weak SEB finances affecting
merchant pricing and future capex, and (3) coal constraints affecting the pace of orders
and execution. On the infra front, our analysis of potential orders in the five sub-segments
suggests a mixed picture. While ordering in roads and ports could accelerate, we expect a
slower growth in metro/railways and airport orders to affect capex growth. Furthermore, we
believe for a sustained capex cycle to emerge, broadbased reforms and creation of new
demand drivers are needed. These include private sector ordering by Railways and
Defence, allowing FDI in retail (among others), streamlining process for land
acquisition/other approvals and a change in the ordering process (related to vendor
qualification, etc.).
Order inflow could disappoint, underweight sector
Street’s sector estimates build in over 25% inflow CAGR until FY13 (based on earnings
estimates), which we believe are at risk, given a likely weak capex cycle. While earnings
estimates for the sector have been cut by 8-10% YTD, more than the earnings risk, we
see risk of order inflow disappointments, and expect the sector to underperform the broad
markets in FY12. Given our cautious view on the power cycle, we retain our NEUTRAL
rating on BHEL and BGR Energy. While we expect the infrastructure and industrial capex
cycle to improve at some point in the future, we remain concerned about the medium-term
performance of the sector. Companies with higher exposure to industrial and infrastructure
capex, include L&T (Restricted), Siemens (Underperform), ABB (Underperform) and Punj
Lloyd (Underperform). Other stocks with a high exposure include Voltas and Thermax
(Both OUTPERFORM, but our order estimates/target prices have been cut). Our key
OUTPERFORM ideas (Crompton Greaves, KEC, Havells and Cummins) in this sector
remain centred on stocks that either sport relatively favourable valuations/lesser earnings
risks or those with high exposure to global growth.
Industrial capex revival continues to
elude
The three key sectors (oil & gas, steel and cement) dictate over 70% of the industrial
orders for Indian E&C firms. Our study of the capex plans of 30 companies across these
sectors and 70 projects makes us conclude that capex growth could remain challenging in
FY12, given: (1) the oversupply in cement, (2) flattish E&P spend and high competition
from foreign vendors, (3) that the bulk of refining orders are already awarded, (4) the gas
supply constraints affecting the pipeline capex and (5) the approval/resource bottlenecks
for large projects in steel despite the promising plans. Compared to the previous downturn,
balance sheets are in a much better shape this time (based on aggregating over 100
companies), but over 70% of the projects in this cycle are in the greenfield mode, (versus
30% in the past cycle), making capex more dependant on various approvals and land
acquisition challenges.
One sector alone cannot create a cycle
Industrial capex spend, in our view, aggregates to over US$80-100 bn over a five-year
plan, with bulk of the capex stemming from four industries: cement, steel, oil & gas
E&P/refining and automobile, of which the first three are critical drivers of orders for Indian
equipment firms. Past trends suggest that capex in these sectors typically have a strong
correlation with each other, which is what creates cycles.
Ability to fund not a concern
Our bottom-up aggregation of cash flows and leverage of over 100 companies across
these sectors suggests that operating cash generation for corporates although strong has
not seen much growth in the past two years, and this probably explains the demand side
moderation (not much margin improvement), which led to slower capex growth in the
economy.
Land and approvals more critical in this cycle
Our analysis of project level activity in the cement and steel sectors since FY03 suggests
that it was much easier for plans to translate into orders in the previous cycle, as bulk of
the orders were through brownfield expansion.
The current cycle has several projects that are being planned through the greenfield mode
and hence have longer approval cycles. There are projects which were conceptualised a
few years back but are awaiting environmental approvals or facing land acquisition issues.
We believe that these delays disrupt the capex flow in a cycle and make it more volatile
and difficult to predict
End-market weak; reforms critical
Industrial capex lags a recovery in the power and infra cycle, as order momentum in these
segments dictates demand for commodities which impacts capex. We expect the power
and infra cycle to remain weak in FY12. The Power equipment order cycle is expected to
decelerate due to: (1) bulk of 12th plan orders having been awarded (please see note
dated 20th Sep 2010, reduce exposure to power sector) (2) weak SEB finances impacting
merchant pricing and future capex and (3) coal constraints impacting the pace of orders
and execution. On the infra front, our analysis of potential orders in the five sub-segments
suggests a mixed picture. While ordering in roads and ports could potentially accelerate,
we expect slower growth in metro/railways and airport orders to impact capex growth.
Further, we believe that for a sustained capex cycle to emerge requires broad-based
reforms and creation of new demand drivers. These include private sector ordering by
railways and defence, allowing FDI in retail, among others, and streamlining the process of
land acquisition/other approvals and a change in ordering process (related to vendor
qualification, among other things).
Macro is important
Spend is primarily dictated by GDP growth and investment intensity and, in that respect,
Credit Suisse expects GDP growth to moderate in FY12, raising questions on the
sustenance of some recovery in capex in FY11. Investment intensity, on the other hand,
can be dictated by reforms alone. The key reason for emergence of a large investment
cycle in India from FY04-05 was the reforms in the power sector that were initiated in
FY03. Further, a new wave of investments in infrastructure emerged with the success of
the PPP format in roads and airports. Strength in power and infra capex increased
demand for commodities triggering industrial capex and, more importantly, the length of
the investment cycle was large given that it came on the back of several years of
underspending. Hence, what is required for a new cycle to form in India, is opening up of
new sectors for private participation and reforms in the approval process (including land
acquisition).
Order inflow could disappoint;
UNDERWEIGHT sector
Street’s sector estimates build in over 25% inflows CAGR until FY13 (based on earnings
estimates), which are at risk given a likely weak capex cycle. While year-to-date earnings
estimates for the sector have been moderated by 8-10%, more than earnings risk, we see
more risk from order inflow disappointments. Hence we expect the sector to underperform
broad markets in FY12. Given our cautious view on the power cycle, we maintain our
NEUTRAL rating on BHEL and BGR Energy. While we expect the infrastructure and
industrial capex cycle to improve at some point in future, we remain concerned about the
medium-term fortunes of the sector. Companies with a high degree of exposure to
industrial and infrastructure capex include L&T(Restricted), Siemens (UNDERPERFORM),
ABB (UNDERPERFORM) and Punj Lloyd (UNDERPERFORM). Other stocks with high
exposure include Voltas and Thermax (both OUTPERFORM rated, but our order
estimates/target prices have been cut in prior reports). Our key OUTPERFORM ideas
(Crompton Greaves, KEC, Havells and Cummins) in this sector remain centred on stocks
that either sport relatively favourable valuations/lesser earnings risks or those with high
exposure to global growth.
Orders inflow expectations builds in a recovery
Our sector order inflow estimates point to an ~25% growth in sector inflows in FY12 and
build in a view of recovery. We believe that consensus estimates are pricing in similar
growth for FY12. Lacklustre order activity could cap multiples for the sector
Rerating unlikely without broad-based reforms
Sector valuations have corrected, but at a forward P/E of 18x, prices in strong growth
expectations in the medium term. Given the risk to sector inflows, we believe the case for
a rerating is not evident.
L&T (Restricted)
Over 60% of inflows for L&T depend on infra and industrial capex. Post the Dec quarter
results, management had highlighted that delays in large order finalisations could impact
their FY11 order inflow guidance that stands at 25% YoY. Since then, while the Rs150 bn
worth Hyderabad metro has been financially closed (Early April), the NTPC bulk tender for
boilers (11X660 MW) has been delayed as one of the bidders is contesting a
disqualification in the Supreme Court. Delay in finalisation of this tender implies that
NTPC’s Rs200 bn tender for 9X800 MW sets could also get delayed. L&T reports on 19
May, and management comments suggest that order traction at the current time (tender
activity) is relatively better than that in the last year. Guidance for the next year is expected
during the announcement of March quarter results.
Siemens (maintain UNDERPERFORM)
Siemens derives over 45% of its revenue from industrial orders. The company has
witnessed some improvement in the short cycle industrial product orders last year;
however, orders from the industrial projects division were muted. Within the projects
segment, Siemens has strong capabilities in the Metals sector, and some order traction is
anticipated for that segment this year. However, with other segments on both industrial
and infra front not expected to do well, it might be difficult for Siemens to achieve street’s
high growth numbers. The stock is pricing in over 20% growth in order inflows p.a. in the
medium term, which we believe could be difficult to achieve.
The ongoing open offer (Siemens AG (that owns 55.2%) has announced an open offer to
buy ~20% of outstanding shares at Rs930/share) has supported the stock over the past
few months. We expect the stock to track fundamentals post completion of the offer on 13
April. We recently downgraded the stock to an UNDERPERFORM (note dated 31 March,
Power T&D: Chinese competition intensifies), and we reiterate our view given the risks to
growth.
ABB (maintain UNDERPERFORM)
ABB has over 40% exposure to industrial ordering, where we continue to see risk for ABB.
ABB’s order inflows declined over 35% in CY10, and our view of order inflows at levels
similar to those in CY08 could be at risk. Our view of recovery in order inflows was based
on ABB’s win in a large HVDC order as well as recovery in the T&D order cycle and the
benefits from the new domestic manufacturing/JV clauses. With ABB India’s portion of the
US$1 bn order being only about 15% of the order and competition increasing in the T&D
space, our estimates are at risk, in our view. Our earnings numbers are, however, at the
bottom of street’s estimates. Hence, we maintain an UNDERPERFORM rating on the
stock.
Punj Lloyd (maintain UNDERPERFORM)
Our concerns on Punj Lloyd are largely centred around weak execution in the past,
several pending claims in international subsidiary on past projects and high leverage.
While Punj Lloyd’s order book of Rs280 bn (as of Dec 10—includes Libya orders) was up
19% YoY, revenue growth in the first 9M has declined 35% YoY, largely due to nonmoving
orders in Libya. While management has now removed US$1 bn worth of projects
(in Libya) from the order backlog, we note that there is risk with regards to execution of the
remaining orders (~US$800 mn). Since Punj Lloyd had received advances on the orders
booked under PLL, management highlighted that net of costs, the company was cash
positive on these contracts.
Apart from the concerns around execution of projects in Libya as well as ability to improve
order traction from such geographies in future, auditors have also qualified Rs2.4 bn for
non-provisioning in the ONGC project and Rs655 mn for LDs. The Ensus project is
currently going through a warranty period, and hence Ensus continues to retain £7.7 mn of
retention money and £2.2 mn of guarantees. In the SABIC project, £18 mn of claims by
various subcontractors are still under dispute. Management expects favourable awards in
some of these contracts. We believe that consensus numbers for Punj Lloyd are at risk
and hence maintain our UNDERPERFORM rating on the stock.
Key OUTPERFORM ideas
Crompton Greaves (maintain OUTPERFORM)
Over 40% of inflows for CGL stem from their international business where order traction is
improving. In addition, CGL has very limited exposure to industrial and infra sectors. The
domestic T&D business, which accounts for over 35% of sales, is witnessing heightened
competitive activity, especially in high voltage orders; however, we expect CGL to maintain
market share given a better cost structure than peers and entry into the 765 KV substation
segment. We maintain our OUTPERFORM rating on CGL as it overtrades at a steep
discount to sector valuations (32%) despite a relatively better earnings track record.
Havells (maintain OUTPERFORM)
We remain positive on Havells on account of recovery (stabilisation) of performance at its
International subsidiary, Sylvania (accounts for 50% of revenues for Havells). Increasing
mix of consumer business is also a positive, in our view, as a higher exposure to branded
products business (by launching four products—mixer/grinder/juicer, toaster, iron, hand
blender) shields the company from pricing pressures and also helps outgrow competition
by gaining share at the expense of the unorganised market. Our recent interaction with
management also indicated a positive outlook from the company. On the domestic front,
management hoped to achieve 18-20% sales growth, with 11.5% EBITDA margins in
FY11, with margins to sustain next year, led by pricing actions. Sylvania is also tracking to
achieve over 8% margins next year. Attempts to increase mix of fixtures (high margins):
lamps, increase in mix of emerging markets are key drivers. Europe is expected to have
flat revenue next year, but stronger growth in LATAM and product introductions in new
geographies such as India should help improve revenue growth. Maintain OUTPERFORM.
Cummins (maintain OUTPERFORM)
Cummins has over 30% exposure to exports where order traction appears strong.
Cummins Inc. has also decided to use India as a base for low KVA engines for exports to
Asia and Africa, and this should help support growth rates for exports in the coming years.
In terms of domestic business, management appeared positive on demand and
highlighted that the company’s new mid-range capacity allocation from Tata Cummins will
also get fully utilised by the next year. Margins remain a key area of uncertainty (and a risk)
as impact of commodity costs will now start reflecting in costs; however, price hikes are
yet to be taken. While Cummins also gets impacted by weak industrial and infra activity,
what sets it apart from most other industrial equipment firms is the dominance of its
product portfolio and diversified end-market exposure even within the industrial segment.
We maintain our OUTPERFORM rating on Cummins.
KEC international (maintain OUTPERFORM)
We retain our positive view on KEC international given its high exposure to international
orders (over 55%), which shield the company from steep competitive activity in the T&D
sector in India. KEC has also gained qualifications in the substation EPC segment,
including the HV segment. Powergrids relaxed criterion for substation EPC orders should
help KEC win orders next year, in our view. KEC also benefits from a potential recovery in
railway segment ordering in the coming years—although we do not build in significant
orders from the rail segment in FY12.
Removed from our key stock ideas
We remove both Thermax and Voltas from our key stocks lists, given their exposure to
industrial/infra capex, although we maintain an OUTPERFORM rating on both. Over the
past three months, we have reduced our order estimates and target prices for both stocks
to reflect that view. (On Voltas please refer note dated 3 Feb, Voltas: PAT below estimates;
Moderating expectations to reflect weak near term, and on Thermax please refer note
dated 16 March, Thermax: Order loss to Cethar Vessels; low visibility on utility order wins
to impact valuations).
However, we maintain our OUTPERFORM rating on Voltas on account of favourable
valuations relative to the sector, strong balance sheet and high exposure to capex in the
Middle East (order pipeline in geographies such as Saudi Arabia, Qatar is very strong, as
per management comments).
On thermax, we maintain our Outperform stance largely due its entry into utility scale
orders. While order traction for Thermax has been much slower than peers, in this
segment, we note that a strong balance sheet, good management capabilities, strong
execution capabilities and presence of a strong technology partner should enable
Thermax to drive significant traction in inflows in the next few years. That said, we do not
see any major traction in inflows in the next few quarters.
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