Better-than-expected growth in the Index of Industrial Production, specifically in manufacturing, may have raised expectations that the capital goods sector may see improved order inflows. The December quarter may throw cold water on those expectations, however. News on the order inflows front continues to disappoint, which indicates that future revenue growth may do so too.
There are several reasons for this. One, the manufacturing sector has surplus capacity and even with a pickup in consumer demand or economic activity, it may not see the need to invest in capacity addition. This holds true of sectors ranging from consumer durables, industrials, power and commodities such as cement and steel.
Two, demonetization has made analysts cautious on growth forecasts for the next 12 months. The International Monetary Fund recently trimmed India’s growth forecast for fiscal year 2017 to 6.6% from the earlier 7.6%. The fallout of this will be felt by the capex cycle, in turn delaying recovery of the capital goods industry. Lastly, lending institutions may be flush with funds but are not fully convinced of the economic recovery to back the capital expansion plans of Indian industry.
The country’s No. 1 power equipment manufacturer, Bharat Heavy Electricals Ltd (Bhel), is likely to report barely a fourth of order inflows in the December quarter, compared to the year-ago period. Emkay Global Financial Services Ltd expects order inflows may fall by 36% for its universe of eight leading firms, including Bhel. The order inflows reported may be from public sector contracts like transmission and distribution of power or from process industries in the private sector.
Revenue growth is expected to be weak, especially for those doing engineering, procurement and construction work. Demonetization impacted cash flows for payment of contract workers and projects got delayed, which will affect revenue accretion on these projects during the quarter. Meanwhile, operating margins would be flat or a tad lower than a year before, given that costs have risen.
A few exceptions could be those with an exposure to the renewable energy sector, as orders are still coming in. Also, those with export orders may maintain profitability.
That said, the BSE Capital Goods index has recovered since January, perhaps on hopes of budgetary incentives to boost infrastructure and domestic manufacturing. Also, post-results management commentary will be worth observing, according to a report by HDFC Securities Ltd. Signals of a revival in order inflows are critical for investors to take interest in the sector.