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Prefer companies with exposure to the East;
margin erosion less likely for EPC players
As interest rates peak, EPC stocks should
outperform equipment suppliers, particularly
given their recent disproportionate de-rating
We downgrade ATD to Neutral; see
significant risk to consensus in ABB and
CRG; prefer KPP and KEC
Prefer exposure to East over West. Amid the global economic
slowdown, India and the MENA region should remain key sources of
growth, particularly as loan growth in these regions is likely to remain
robust. Except for CRG, and to some extent KEC, we believe most
companies under coverage remain well placed in this regard.
Margin erosion less likely for EPC players. After a 300bp decline in
the last five years, EBITDA margins of engineering, procurement and
construction (EPC) players have stabilized. But equipment margins
have shown further signs of deterioration in the last quarter with rising
competition in the transformer/substation segment. In addition, larger
order books of EPC players offer better visibility on margins than
equipment suppliers, implying lesser risk to earnings estimates.
As interest rates peak, EPC players are likely to outperform. EPC
players remain significantly geared compared to equipment suppliers,
which makes them highly rate sensitive, particularly as a large portion
of their debt is in the form of short-term working capital loans. In the
past 12 months, EPC stocks have shown a negative correlation of
c86% with interest rates. Hence, when the rate cycle turns, EPC stocks
will most likely outperform equipment suppliers.
EPC valuations more attractive by far. Despite c16%
downgrade in consensus earnings in the past 12 months, EPC
players trade at discounts of c60% to their historical average
forward PE and c15% to the average valuation at the 2008
trough. On the other hand, multiples for equipment suppliers
remain vulnerable with potential downside of c33% if valuations
were to revert to 2008 crisis levels.
Rating and estimate changes. With our cautious view on
execution and margins, we trim FY12-13e EPS by c6-7% and
remain 9-10% below consensus. While our estimates are in line
with consensus for KPP, we are significantly below (c21-23%)
for CRG and ABB. In addition, we lower estimates for ATD,
downgrading our rating to Neutral. KPP and KEC remain our
preferred plays, given their strong growth and attractive
valuations. ABB remains our key UW in the sector
click link below for company reports:
Investment summary
Amid the global slowdown, we prefer exposure to the East over
the West and believe margin erosion is less likely for EPC players
As interest rates peak, the highly geared EPC players will likely
outperform equipment suppliers, particularly given the former’s
disproportionate de-rating
We trim our FY12-13 EPS estimates by c6-7%; see significant risk
to consensus earnings in ABB and CRG; downgrade ATD to
Neutral; prefer KPP and KEC
Prefer exposure to East over
West
As global economies slow down, we believe the
East still offers better growth opportunities with
India and the Middle East and North Africa
(MENA) region expected to grow by c8% and
4.5%, respectively, in 2012.
As became evident in the initial phase of this
financial crisis in 2008-09, the impact of a global
meltdown on the Indian economy is likely to be
much smaller than for other regions in the
emerging world.
We trim our FY12-13e EPS by
c6-7%, putting us c9-10%
below consensus
Given the deteriorating demand environment and
increasing pricing pressure for some companies,
we have trimmed our FY12-13 EPS estimates on
average by c6-7% for the sector. This highlights
our cautious view on execution and margin
progression. In addition, given the weaker
commentary coming out of the MENA region and
the power grid, we have assumed a more
conservative view on growth in new orders in
FY12-13, reducing our sector order intake
estimate by c3% for FY13e.
We remain 9-10% below consensus on our
estimates and believe that the risk to consensus
lies in lofty margin expectations. We are currently
c40bp below consensus on the estimates on sector
margins for FY12-13.
Our biggest disconnect with consensus is on ABB
and Crompton Greaves, where we are c23% and
c21% below consensus on CY11e and FY12e
EPS, respectively. We remain broadly in line with
consensus on KPP and Siemens, albeit with
marginally lower estimates.
Downgrade ATD to Neutral;
lower TPs across the board
With a weak order book and significant pricing
pressure from competition, we believe the
anticipated margin recovery is likely to be muted
for ATD. Hence, we have taken a cautious view
on execution and margin progression, lowering
our CY11 and CY12 EPS estimates by c14% and
8%, respectively. Currently, we are c15-18%
below consensus on CY11-12e EPS and believe
the company will most likely disappoint in the
coming quarters. Due primarily to the earnings
cuts, we have lowered our TP for ATD to INR235
from INR270. We expect the stock to remain
range bound unless there is more clarity on the
demerger. This leads us to downgrade our rating
to N from OW.
We have also cut target prices in the range of 5-
20% across the board, due primarily to earnings
cut and higher cost of capital. We highlight the
changes to our estimates, ratings and target prices,
along with a comparison to consensus, in the
tables below.
KPP and KEC remain our
preferred stocks and ABB is
our least preferred
KPP (OW, TP INR165): With a record backlog of
INR106bn and strong visibility of c2.4x FY11 sales,
we believe KPP remains well placed to deliver
strong sales growth. We expect margins to remain
range bound and cash flow to improve somewhat in
FY12 and more substantially in FY13. We have
lowered our FY12-13 EPS estimates by c5-7% and
now forecast earnings growth of c20-22% in FY12-
13. At a 5.4x FY13e PE, we continue to find the
stock attractive and hence reiterate OW on the stock.
KEC (OW, TP INR86): Like KPP, KEC should
deliver strong revenue growth benefiting from
strong order inflow. However, we believe margins
are likely to decline this year because of a change
in project mix. This, in our opinion, may confine
earnings growth to low double-digits this year.
We have lowered our FY12-13 EPS estimates by
c9-10% and forecast earnings growth of 11.3% in
FY12 and 28.4% in FY13. At 4.9x FY13e PE, the
stock remains attractive and hence we reiterate
our OW rating.
ABB (UW, TP INR570): With a scarcity of large
orders and margin recovery threatened by
competition, we believe ABB is likely to again
miss earnings expectations. The company recently
highlighted increasing pricing pressures in an
interview and noted that the parent has no intention
to further increase its stake in the Indian business.
Consequently, we continue to find the stock
overvalued at 34.4x CY12e PE and believe that it
needs to shed its takeover premium. We have
lowered our CY12 and CY13e EPS estimates by
c5-8% and cut our TP to INR570 from INR590.
We remain c12-16% below consensus on CY12-
13e EPS and c23% below consensus on CY11e
EPS. We reiterate our UW rating.
Key risks
The key risks to our industry and company
estimates (orders and earnings) include:
Delay/cancellation of transmission projects,
particularly in the MENA region
Resurgence in pricing pressure due to
continued competition
Significant slowdown in domestic industrial
capex
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Prefer companies with exposure to the East;
margin erosion less likely for EPC players
As interest rates peak, EPC stocks should
outperform equipment suppliers, particularly
given their recent disproportionate de-rating
We downgrade ATD to Neutral; see
significant risk to consensus in ABB and
CRG; prefer KPP and KEC
Prefer exposure to East over West. Amid the global economic
slowdown, India and the MENA region should remain key sources of
growth, particularly as loan growth in these regions is likely to remain
robust. Except for CRG, and to some extent KEC, we believe most
companies under coverage remain well placed in this regard.
Margin erosion less likely for EPC players. After a 300bp decline in
the last five years, EBITDA margins of engineering, procurement and
construction (EPC) players have stabilized. But equipment margins
have shown further signs of deterioration in the last quarter with rising
competition in the transformer/substation segment. In addition, larger
order books of EPC players offer better visibility on margins than
equipment suppliers, implying lesser risk to earnings estimates.
As interest rates peak, EPC players are likely to outperform. EPC
players remain significantly geared compared to equipment suppliers,
which makes them highly rate sensitive, particularly as a large portion
of their debt is in the form of short-term working capital loans. In the
past 12 months, EPC stocks have shown a negative correlation of
c86% with interest rates. Hence, when the rate cycle turns, EPC stocks
will most likely outperform equipment suppliers.
EPC valuations more attractive by far. Despite c16%
downgrade in consensus earnings in the past 12 months, EPC
players trade at discounts of c60% to their historical average
forward PE and c15% to the average valuation at the 2008
trough. On the other hand, multiples for equipment suppliers
remain vulnerable with potential downside of c33% if valuations
were to revert to 2008 crisis levels.
Rating and estimate changes. With our cautious view on
execution and margins, we trim FY12-13e EPS by c6-7% and
remain 9-10% below consensus. While our estimates are in line
with consensus for KPP, we are significantly below (c21-23%)
for CRG and ABB. In addition, we lower estimates for ATD,
downgrading our rating to Neutral. KPP and KEC remain our
preferred plays, given their strong growth and attractive
valuations. ABB remains our key UW in the sector
click link below for company reports:
CRG: Earnings risk undermines valuation
ATD: Upside to margin unlikely to materialize
KEC: Likely to deliver strong growth
KPP: Earnings growth at inflection point
SIEM: Margins likely to come under pressure
ABB: Valuation defies weak fundamentals
Amid the global slowdown, we prefer exposure to the East over
the West and believe margin erosion is less likely for EPC players
As interest rates peak, the highly geared EPC players will likely
outperform equipment suppliers, particularly given the former’s
disproportionate de-rating
We trim our FY12-13 EPS estimates by c6-7%; see significant risk
to consensus earnings in ABB and CRG; downgrade ATD to
Neutral; prefer KPP and KEC
Prefer exposure to East over
West
As global economies slow down, we believe the
East still offers better growth opportunities with
India and the Middle East and North Africa
(MENA) region expected to grow by c8% and
4.5%, respectively, in 2012.
As became evident in the initial phase of this
financial crisis in 2008-09, the impact of a global
meltdown on the Indian economy is likely to be
much smaller than for other regions in the
emerging world.
We trim our FY12-13e EPS by
c6-7%, putting us c9-10%
below consensus
Given the deteriorating demand environment and
increasing pricing pressure for some companies,
we have trimmed our FY12-13 EPS estimates on
average by c6-7% for the sector. This highlights
our cautious view on execution and margin
progression. In addition, given the weaker
commentary coming out of the MENA region and
the power grid, we have assumed a more
conservative view on growth in new orders in
FY12-13, reducing our sector order intake
estimate by c3% for FY13e.
We remain 9-10% below consensus on our
estimates and believe that the risk to consensus
lies in lofty margin expectations. We are currently
c40bp below consensus on the estimates on sector
margins for FY12-13.
Our biggest disconnect with consensus is on ABB
and Crompton Greaves, where we are c23% and
c21% below consensus on CY11e and FY12e
EPS, respectively. We remain broadly in line with
consensus on KPP and Siemens, albeit with
marginally lower estimates.
Downgrade ATD to Neutral;
lower TPs across the board
With a weak order book and significant pricing
pressure from competition, we believe the
anticipated margin recovery is likely to be muted
for ATD. Hence, we have taken a cautious view
on execution and margin progression, lowering
our CY11 and CY12 EPS estimates by c14% and
8%, respectively. Currently, we are c15-18%
below consensus on CY11-12e EPS and believe
the company will most likely disappoint in the
coming quarters. Due primarily to the earnings
cuts, we have lowered our TP for ATD to INR235
from INR270. We expect the stock to remain
range bound unless there is more clarity on the
demerger. This leads us to downgrade our rating
to N from OW.
We have also cut target prices in the range of 5-
20% across the board, due primarily to earnings
cut and higher cost of capital. We highlight the
changes to our estimates, ratings and target prices,
along with a comparison to consensus, in the
tables below.
KPP and KEC remain our
preferred stocks and ABB is
our least preferred
KPP (OW, TP INR165): With a record backlog of
INR106bn and strong visibility of c2.4x FY11 sales,
we believe KPP remains well placed to deliver
strong sales growth. We expect margins to remain
range bound and cash flow to improve somewhat in
FY12 and more substantially in FY13. We have
lowered our FY12-13 EPS estimates by c5-7% and
now forecast earnings growth of c20-22% in FY12-
13. At a 5.4x FY13e PE, we continue to find the
stock attractive and hence reiterate OW on the stock.
KEC (OW, TP INR86): Like KPP, KEC should
deliver strong revenue growth benefiting from
strong order inflow. However, we believe margins
are likely to decline this year because of a change
in project mix. This, in our opinion, may confine
earnings growth to low double-digits this year.
We have lowered our FY12-13 EPS estimates by
c9-10% and forecast earnings growth of 11.3% in
FY12 and 28.4% in FY13. At 4.9x FY13e PE, the
stock remains attractive and hence we reiterate
our OW rating.
ABB (UW, TP INR570): With a scarcity of large
orders and margin recovery threatened by
competition, we believe ABB is likely to again
miss earnings expectations. The company recently
highlighted increasing pricing pressures in an
interview and noted that the parent has no intention
to further increase its stake in the Indian business.
Consequently, we continue to find the stock
overvalued at 34.4x CY12e PE and believe that it
needs to shed its takeover premium. We have
lowered our CY12 and CY13e EPS estimates by
c5-8% and cut our TP to INR570 from INR590.
We remain c12-16% below consensus on CY12-
13e EPS and c23% below consensus on CY11e
EPS. We reiterate our UW rating.
Key risks
The key risks to our industry and company
estimates (orders and earnings) include:
Delay/cancellation of transmission projects,
particularly in the MENA region
Resurgence in pricing pressure due to
continued competition
Significant slowdown in domestic industrial
capex
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