Dismal performance during the last four quarters and a gloomy macro-economic outlook has not deterred capital equipment makers from expanding capacity. The hope that the power scenario has to sooner or later get ironed out has led these firms to dip into their coffers to fund ambitions plans, mainly in the power equipment space.
Bharat Heavy Electricals Ltd is pumping in Rs 1,700 crore to expand power equipment capacity by 5,000 MW (megawatts) to touch 20,000 MW by fiscal 2012. Smaller firms are toeing the line too. Thermax Ltd along with its joint venture partner, Babcock-Wilcox will invest about Rs 800 crore to set up a 3000 MW super critical boiler manufacturing facility. Multinationals too are in the fray with firms like ABB Ltd localising manufacture of higher-end transformers and circuit breakers in India. A note by Asian Market Securities Ltd says that the total domestic boiler capacity will touch 30,000 MW per annum by fiscal 2014.
Yet most capital goods firms’ December quarter performance was hardly impressive. Although they clocked revenue growth on the back of better execution and deliveries, operating margins weakened. Within capital goods, the boiler turbine generator segment was hit by order cancellations and most other power equipment segments saw hardly any order inflows.
But, perhaps the positive outlook and capacity additions by these firms has overshadowed the poor December quarter performance. The BSE capital goods index, which fell 13% from April 2011, started moving into positive territory since November, when it has been an outperformer. The news on the government’s intent to bring in import tariff barriers for the sector also improved sentiment.
Is this bullishness justified? True, capital goods makers like BHEL, Thermax, BGR Energy and Crompton Greaves Ltd have strong cash and bank balances. Low-leverage (with debt:equity below 1), rich parentage for multinationals and operating cash flows will help back expansions, without hurting balance sheets.
But the point to note is that overcapacity in the power equipment business could lead to fall in capacity utilisations 18 months from now. A note by Religare Securities Ltd says that even the ambitious outlay for about 75,000 MW of additional power generation in the 12 th Plan (April 2012- March 2017), implies annual capacity addition of about 15,000 MW, which is way below the capacity of the equipment makers.
The natural fallout will be stiff competition, which will impact realisations and margins perhaps 12-18 months hence. Poor earnings momentum in the medium to long term could hit valuations even as the country powers up.