The Indian subsidiaries of multinational firms in the capital goods segment have done rather well in the March quarter. Revenue of firms such as Siemens Ltd, ABB Ltd and Areva T&D India Ltd grew in excess of 20% compared with a year before. Profitability at the operating level has also improved. But the question is: does this justify the sky-high valuations enjoyed by these firms compared with Indian peers? Or, are investors fooling themselves?
Taking Friday’s closing price, the shares of Siemens and Areva trade at a trailing price-earnings (P-E) multiple of 36-38 times. But then, that has been the case historically as well. Five-year data—from May 2006 till date—indicates the two firms traded at an average P-E of around 38. ABB has historically trounced all capital goods companies commanding an average P-E of 60.
Needless to say, these are rich valuations by any measure. In contrast, the benchmark Sensex index on the Bombay Stock Exchange trades at an average trailing P-E multiple of 20, while the BSE Capital Goods index trades at a trailing P-E of 32. The Indian heavyweight in the segment, Bharat Heavy Electricals Ltd (Bhel), trades at an average of around 23 times past P-E.
Indian investors have long favoured multinational firms for their strong parentage, transparency in accounting and corporate governance, in addition to their rich coffers and technological prowess. Until a decade ago, multinationals were key bidders in process segments such as heavy engineering, power and energy and water treatment products.
Now, with access to global technology Indian firms such as Bhel, Crompton Greaves Ltd and even mid-cap firms such as Thermax Ltd, BGR Energy Systems Ltd and KEC International Ltd have made their presence felt in these businesses. Chinese and Korean firms, too, are competing aggressively with 20-30% cheaper pricing in the boiler-turbine and power products segment.
Relaxation of qualifying norms by customers such as Power Grid Corp. of India Ltd has increased competition. Pricing pressure, mainly in the power transmission and distribution (T&D) segment, will weigh on future profit margins.
Of course, March quarter margins for Siemens, ABB and Areva improved from a year ago, thanks to restructuring in the last two years to bring down costs. ABB, for instance, wrote off large sums from its rural electrification segment, which it decided to exit. Siemens’ employee costs and other administration costs as a percentage of sales have steadily come down in several quarters.
Strong balance sheets have contributed to the high valuations. Yet, the operating margins of ABB’s 5.7%, or Areva’s 8.4%, mainly in the T&D segment, are not significantly higher than Indian peers and are lower than the industry average of around 12% (fiscal 2011).
Further, subdued order inflows in the last two quarters are a reflection of strong macro headwinds such as rising interest and raw material costs. This is likely to slow the pace of execution and capex for long-gestation projects, paring valuations for the capital goods sector as a whole. Indeed, shares of some firms such as Siemens and ABB have appreciated three times in the last five years.
A series of buy-backs at a hefty premium to the market price in the recent past has stirred investor interest in these stocks.
Analysts’ consensus is for a P-E of 15-20 times one-year forward earnings for the sector as a whole. Siemens, ABB and Areva still trade in a much higher range than that.
While multinationals may enjoy a premium valuation, the likely slowdown in investment demand and in order inflows, a level playing field with intense competition and pressure on margins will see a reduction in valuation gap. This, in turn, would cap upsides for multinational firms in the near term.
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