Too early for a re-rating in capital goods space

Mumbai: The recent performance of the BSE capital goods index, up 12% versus 5.9% gain for the Sensex since the beginning of the June seems to be surprising. That, at a time when the capital goods segment of the index of industrial production is at level seen two years ago and down 16.3% year-on-year in April. So, what is fueling the rally in these stocks?

The government’s infra push for 2013 has raised hopes that the lagging infrastructure sector could be pulled out of the rut. But looking at the past track record, the it might be just all talk, unless execution picks up.

Secondly, there seems to be a tiny spike in number of new project announcements. During the week ended June 10, 74 new investments worth Rs 50,800 crore were identified, which makes up about a fifth of the average announcements (worth Rs 2.5 lakh crore) during a quarter, according to the data compiled by Centre for Monitoring Indian Economy Pvt. Ltd.

The noise of the another 25-50 basis points rate cut during the June 18th Reserve Bank of India policy meeting has also increased because of poor economic growth. India’s GDP fell to a nine year low of 5.3% in the March quarter and industrial output flattened in April after a 3.2% dip in March, much below economists’ expectations.

Edelweiss Securities Limited in a recent report puts it succinctly: The rate cut (along with more over the next 12-15 months) will help trim overall cost of funds and is likely to spur industrial capex. However, we believe policy initiatives like coal and iron ore mining, and environmental clearance will be the key to determine the extent of recovery in industrial spending besides demand from various industries.

Sanjeev Zarbade, capital goods and engineering analyst from Kotak Securities Limited adds, the government needs to encourage private investments since it does not have enough money to fund new projects because of high fiscal deficit of 5.1% of GDP in FY13 and they also need to ensure adequate fuel linkages so that plants run at full capacity.

The only standout company seems to be Larsen & Toubro because of exposure to diversified segments (power, metal, hydrocarbons and infrastructure) that can weather the storm and expectations of growth pick-up in the Middle East market. L&T has also guided for a strong 15-20% growth in order inflow in FY13 compared to 12% slump in FY12, better than analysts’ estimates. But the market has already factored in the positives, since the stock is the top gainer in the capital goods index, up 20% since beginning of June.