Capital goods: No broad based recovery in order inflows yet

Government-led investments have raised domestic market prospects, but conviction about immediate earnings growth trajectory is low right now, say analysts


Both L&T Ltd and BHEL Ltd reported a drop in order inflows for the December quarter.
Both L&T Ltd and BHEL Ltd reported a drop in order inflows for the December quarter.

After a year of underperformance, the BSE Capital Goods index started the New Year on a positive note.

Compared with an 8.7% increase in the Sensex, the capital goods index gained 12.2% in January-February as the companies delivered revenue growth despite a general sluggishness in investment activity.

A Kotak Institutional Equities’ review of six notable companies’ results shows that revenues increased by about 5% in the December quarter.

In the previous two quarters, they grew in the range of 3-5%.

A Motilal Oswal Securities Ltd’s review of 12 companies in the sector shows that aggregate revenues grew 6% from a year ago.

Profits grew at an even faster pace as companies benefited from cost rationalization measures.

“Domestic revenue of industrial companies showed moderate growth in 3QFY17, which is heartening. We attribute the pick-up in domestic revenues to (1) the low base of the past several quarters and (2) modest pick-up in investments in certain sectors such as railways, roads, power generation and transmission,” Kotak Institutional Equities added.

Overall order inflows, which reflect the business environment and future prospects, remained muted.

At an aggregate level, firms reviewed by both Kotak and Motilal Oswal saw a decline in order inflows. Both Larsen and Toubro Ltd and Bharat Heavy Electricals Ltd reported a drop in order inflows. If one excludes these two firms, aggregate orders inflows will rise year-on-year, Motilal Oswal said.

Compared with project-based firms, product companies did better.

ABB India Ltd, Siemens Ltd, Thermax Ltd and GE T&D Ltd reported a year-on-year improvement in order inflows.

According to Motilal Oswal, there is a rise in inquiries for small-ticket orders in conventional segments. Another broking firm, Sharekhan Ltd, says it is expecting better order inflows on improved prospects in international markets.

While the commentary should provide comfort to investors, everybody is not convinced about the future growth trajectory yet. Jefferies India Pvt. Ltd’s study of ordering activity in West Asia, a large engineering procurement and construction market for Indian firms, shows that contract awards fell in the first 10 months of the current fiscal year.

Of course, government-led investments in India have raised domestic market prospects. But as Kotak points out, conviction about immediate earnings growth trajectory is low right now. “The high valuations of industrial and infrastructure stocks reflect the market’s confidence in a recovery of revenues and profits in the medium term. We do not dispute the medium-term potential of investment in India but suspect that revenues will continue to be weak for the next few quarters,” Kotak adds.

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