Common sense would say that the capital goods sector will be hit badly as investment demand—the engine of the economy during the boom years—stalls. With demand faltering, what would be the point of setting up new capacity?
But would that argument hold in the power equipment sector, where the government is driving demand? Last week’s analyst conference called by ABB India provided an opportunity to check how deep the downturn was in the sector and, more broadly, the strength of investment demand.
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New orders received by ABB India during the December quarter fell by 37.1%, against the year-ago period. New order inflow has been declining throughout 2008, but the fall has been very sharp in the December quarter.
That fits in with the macro numbers, which show that the year-on-year (y-o-y) growth rate of gross fixed capital formation fell from 15% in the September quarter to 5% in the December quarter. For ABB India, the decline was sharper because it exited from the rural electrification business during the quarter on account of logistical problems and a longer working capital cycle.
Here is the quarterly break-up of ABB India’s growth in new orders: March quarter: up 35% y-o-y; June quarter: up 11%; third quarter 13% and fourth quarter -37%. Thanks to the earlier orders, however, ABB India’s order backlog at the end of 2008 was 23% higher than a year ago.
At the meet, the company was optimistic about the prospect of future orders, particularly in the transmission sector from the revised Accelerated PowerDevelopment and Reforms Programme and from the railways. It sees good order inflow from industries such as cement, iron and steel, oil and gas, and aluminium. It also says that the government’s fiscal stimulus packages will give a push to the infrastructure sector. But there are several caveats to that rosy view.
With commodity prices down, capital expenditure may be delayed. That has already happened in the cement sector. The working capital cycle is being extended—trade debts are now paid on an average in 140 days, from 125 days in earlier years.
The pace of new orders is crucial, because ABB India’s order backlog at the end of 2008 was Rs6,162 crore, while its revenues for the year were Rs6,967 crore. So it’s not as if the backlog is going to last for years. The management has indicated that order execution may be slower this year. What’s more, the lower revenues will push down margins, which will also be under pressure from the slowdown in the automation business that accounts for two-fifths of revenues. A slowdown in orders is likely even in the power sector on account of the elections and, thereafter, a stable government is critical for taking up projects. It is these uncertainties that have led to the stock trading at around 14 times calendar 2009 earnings. The flip side for ABB, however, lies in its good financials (its net debt to equity ratio is negative), which are not just a source of comfort in uncertain times, but will also help the firm be the first off the block when good times return.
Graphics by Ahmed Raza Khan / Mint