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Capital Goods
Capital Goods (CG) Index – Still in doldrums
During 1QFY2012, the CG index outperformed the broader
indices and ended with a gain of 5.1% in absolute terms,
outperforming the Sensex by 8.2%. After reporting negative
returns in the first two months of the quarter, the CG index
bounced back in June with ~6% returns in absolute terms.
This was largely aided by the recent rally in the broader markets.
In addition, the spike in CG production reported through IIP
numbers released in June had a positive impact on the CG
index. However, we believe the surge in CG stocks is a temporary
event, given the deteriorating macro enviroment – lower-thanexpected
industrial capex and higher working capital requirements
Companies in our CG universe reported a mixed performance
during the quarter. ABB and Jyoti Structures emerged as the
major gainers, up 9.9% and 4.8%, in absolute terms and
outperformed the Sensex by 13% and 7.8%, respectively.
BGR Energy tumbled the most, declining by 5.9%, in absolute
terms and underperformed the Sensex by 2.8%; slackening order
inflows and poor earnings visibility remain as an overhang on
the stock. BHEL faced downward pressure partially due to the
proposed FPO, before recovering in the recent market rally.Concerns over the sector loom large
Interest rate heads northward: Elevated interest rates remain a
cause of concern, given the cascading impact on industrial capex
(lower capacity additions) and, thereby, demand for capital
goods. Muted demand in terms of lower inflows will have a
direct impact on companies in our coverage universe.
Additionally, high commodity prices are likely to continue
impacting the profitability of CG companies. However, in our
view, both inflation and interest rates are close to peak levels
and are likely to see some respite from 2HFY2012.
Coal deficit – A key concern: With the Indian coal sector
struggling to meet the demands of the power sector, the
perceived shortage in coal supply casts a grim outlook on the
power sector. Further, the coal sector is facing problems over
coals blocks (No-Go regions declared by the Environment
Ministry), thereby pressuring coal supply. However, the
environment ministry has agreed to relax the 'No-Go region'
norms in certain cases in order to cope with the massive capacity
expansion planned in the country.
Power sector hurdled with delays in capacity addition: Most of
the companies in our CG universe have their fortunes directly
linked to the pace of the power sector's growth in the country.
India has a poor track record in this regard, with only 50-60%
of the total planned capacity added during several of the
previous five-year plans. For the Eleventh Plan, the capacity
addition target was revised to 62,374MW (78,000MW), of
which only 57% has been achived till May 2011. As per the
planning commission, around 17,600MW of capacity addition
is planned in FY2012, which also seems challenging. As per
our analysis, we estimate a total capacity addition of 42,000MW
at the end of the Eleventh Plan.
Key developments during the quarter
ABB (CMP/TP:`876/`637) (Rating: Sell) ABB plans to invest
~US$24mn in India to manufacture a new range of miniature
circuit breakers (MCB), residual current circuit breakers (RCCB)
and surge protection devices (SPD). The new manufacturing
facility will be set up in Nelamangala campus in Bangalore.
The plant will manufacture a new range of protection devices
used in residential and commercial buildings, industrial and
renewable energy applications, data centres and
telecommunications industries to protect installations against
over-current, short circuits and leakage current.
Areva T&D (CMP/TP: `257/–) (Rating: Neutral): Areva T&D
bagged orders of Electric BoP from Essar Projects and L&T Power.
The combined value of the orders is `410cr. The scope of work
includes supply and installation of electrical BoP solutions for
which Areva T&D India will manufacture and install
gas-insulated substations, air-insulated substations, distribution
and power transformers, and low-voltage switchboards.
BHEL (CMP/TP:`2,047/–) (Rating: Neutral): BHEL secured an
order for steam turbine generators for a new rating of 700MWe
nuclear sets from Nuclear Power Corporation of India for its
2x700MWe Kakrapar Nuclear Power Station (Units 3 and 4) in
Gujarat. The order is in consortium with Alstom. BHEL's share
in the contract is worth `880cr.
Crompton Greaves (CMP/TP:`259/`300) (Rating: Buy)
Continuing with its strategy of pursuing inorganic growth,
Crompton Greaves concluded two overseas acquisitions,
viz. Sweden-based Emotron Group and US-based QEI, Inc.
We believe the acquisition will enable the company to become
a stronger and more comprehensive player in the industrial
and power systems business and build capabilities by leveraging
its existing product portfolio. Further, the overseas buyouts will
help the company offset the sluggishness in the local
transmission and distribution markets.
KEC International (CMP/TP:`79/`115) (Rating: Buy): KEC
International witnessed impressive order inflow during the
quarter. In the domestic T&D segment, the company secured
orders worth `600cr. KEC International also fared well in the
Middle East and African markets by securing orders totaling
`548cr. SAE Towers contributed `273cr to the order book. New
segments of water and railway also booked orders worth `92cr.
Jyoti Structures (CMP/TP:`85/`104) (Rating: Buy): Jyoti
Structures secured orders totaling `524cr for substation and
transmission projects in India and Bhutan. The company's
subsidiary, Jyoti Structures Africa Pty. Ltd., won another contract
from ESKOM (South African Power Utility) worth `225cr for the
execution of 765kV and 400kV lines.
Thermax (CMP/TP:`594/–) (Rating: Neutral): Thermax bagged
an order worth `366cr for a 120MW captive power plant for
supplying two blast furnace gas-fired boilers and one steam
turbine generator. The company also received an order valued
at `403cr to supply circulating fluidised bed combustion (CFBC)
boilers for a co-generation plant. Management is scouting
overseas to buy a company with a technological edge in water
waste management to strengthen its presence in the water
treatment segment. The size of such an acquisition is expected
to be around US$100mn.
1QFY2012 expectations: We expect companies in our
CG universe to post cumulative top-line growth of 17% yoy.
This would primarily be driven by BHEL and Jyoti Structures,
which are expected to post strong revenue growth of 25% and
24% yoy, respectively. KEC International and Thermax are also
likely to maintain steady top-line growth of 18% and 14.1%
yoy, respectively. BGR’s top line is expected to drop by 15% yoy
on a high base. In the T&D equipment segment, we expect ABB
and Areva to report top-line growth of 15% and 14% yoy,
respectively, while Crompton Greaves is likely to post muted
growth of 8% yoy.
On the operating front, we expect our universe companies to
report flat margins at ~12.3%. ABB is likely post a margin
improvement of 345bp yoy due to fewer expected cost
provisions. KEC International is likely to post a slight
improvement of 52bp yoy because of increased contribution
from SAE Towers. On the other hand, we expect Thermax to
report a 115bp yoy dip in OPM to 11%. Similarly, BGR and
Crompton Greaves are expected to report a margin dip of 44bp
and 42bp yoy, respectively.
The expected top-line growth of 17% yoy along with flat margins
would result in ~13% yoy PAT growth for companies in our CG
universe. ABB is likely to report robust profitability growth on a
low base. KEC International is also expected to report strong
PAT growth because of normalised tax rates compared to high
tax incidence in 1QFY2011. BHEL and Jyoti Structures are likely
to maintain steady growth.
Outlook and valuation
Transmission and distribution (T&D): The T&D equipment space
is circled with diverse set of challenges. First, generation delays
are likely to adversely affect growth prospects of T&D equipment
suppliers as the sector has a high degree of correlation with
power capacity addition. Second, the T&D equipment space is
turning competitive on the recent new PGCIL mandate of
separate tendering of sub-stations and circuit breakers.
We believe this would lead to lower order inflows for companies
like ABB, Areva and Siemens, who enjoy a dominant market
share in the high-voltage T&D space.
In the transmission EPC space, KEC International is well placed
in terms of growth prospects. In the last couple of quarters,
KEC International has gained increased traction from Africa
and Americas (SAE Towers), which outlines a huge potential for
the company in these regions. With geographical diversity,
we believe KEC International is insulated against domestic
competition. Jyoti Structures also provides improved revenue
visibility on the back of better-than-expected order inflows during
the previous quarter as well as optimistic management guidance
on future order intakes.
Power equipment: BHEL continues to ride high on the strong
order book (3.2x FY2012E revenue); however, its long-term
concerns over competitive pressures in the BTG space and the
proposed FPO are putting pressure on the stock. NTPC bulk
tendering will be a key for BHEL, Thermax and BGR. In June
2011, five companies including Thermax and BGR placed bids
for the bulk tender.
Valuations: On the valuation front, we believe most companies
in our CG universe are presently trading at premium valuations,
offering a meager upside from current levels. In such a
scenario, we prefer a stock-specific approach. Crompton
Greaves, KEC International and Jyoti Structures are among our
preferred picks.
We believe the challenges outlined in the power sector such as
coal linkages, delays in land acquisition and environmental
clearances will remain a near-term drag for companies in our
CG universe.
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