In the March quarter, gross fixed capital formation fell to 29.4% of gross domestic product (GDP). That is the lowest since the new GDP series started in June 2011 and aptly sums up the state of private investment in the country.
At the industry level, the brunt of this investment slowdown is seen in the financials and order books of capital goods makers. In the March quarter, the revenue of the top seven capital goods makers grew 5% from a year ago, which was a surprise. However, their aggregate order inflows fell 2%, according to data from Kotak Institutional Equities. Larsen and Toubro Ltd missed its order inflow guidance of 0-5% growth for fiscal 2016. In the March quarter, orders fell 9%. Crompton Greaves Ltd’s domestic business and ABB Ltd didn’t fare much better.
Things haven’t improved in the current quarter as well. The manufacturing sector’s purchasing manager index (PMI) for May shows capital goods orders and production growth continue to fall. There is excess capacity (look no further than the power generation industry) in many sectors and firms are repairing leveraged balance sheets and selling non-core assets to stay afloat.
With global growth also not in a rosy shape, and the Middle East, a key market for Indian capital goods makers, battling low oil prices, there is no confidence that foreign orders will save the day.
What’s more worrying is that even the current order book might not lead to revenue growth. Take Bharat Heavy Electricals Ltd’s (Bhel’s) management guidance for instance. It said that of the current order backlog of Rs.1.1 trillion, at least Rs.50,000 crore worth projects are either slow-moving or stressed, according to a note from Religare Securities Ltd. Overall, the weak financials of client firms and the all-too-familiar problems of land and fuel—which still affect many projects—depress the outlook for revenue growth in the current fiscal.
For Bhel, this translates into a shrinking of sales in FY17, compared with the previous year; in turn, leading to more margin pressure. Other firms, too, face margin pressure. As energy and commodity prices have resumed their climb, the margin kick from lower input costs will also wear away.
Unless demand and order inflows perk up, there is no way to justify the rise in the stock prices of capital goods makers. The BSE Capital Goods Index has risen 12.7% since the start of this fiscal (till 2 June), compared with 6% for the Sensex. Kotak Institutional Equities says valuations of industrial stocks are quite stiff even after factoring in a significant recovery in earnings.