The gradual but steadily creeping competition from Chinese and South Korean companies in the capital goods sector could pose a serious threat to the order pipeline and profitability of local equipment makers. Data from orders given out by the largest public sector power transmission firm—Power Grid Corp. of India Ltd (PGCIL)—tell a disconcerting tale of shrinking market share both for Indian giants like Bharat Heavy Electricals Ltd (Bhel) that used to rule the roost in power generation equipment and for multinationals such as ABB Ltd, Siemens Ltd and Crompton Greaves Ltd.
Chinese companies such as TBEA Shenyang Transformer Group, Baoding and Xian XD Transformers and South Korean entities including Hyosung Corp. have turned out to be strong contenders, getting orders in substation and transformer markets. From a three-way share of the transformer market by Bhel, ABB and Crompton in fiscal 2007 and 2008, their individual shares are down to single digits in the last three fiscal years. In contrast, brokerage reports that collate data on PGCIL’s orders show that the share of Chinese companies have steadily risen from 24% in fiscal 2010 to almost 50% in fiscal 2012. In addition, some new entrants from Saudi Arabia have also started bidding.
This will have several implications for the Indian companies. Firms will have to bid lower than before, leading to pressure on margins. A Motilal Oswal Securities Ltd report a few months ago said that transformer prices have declined nearly 25-30% in the last three to four years as more firms chased fewer orders.
The order inflow too has dried up. Kotak Securities Ltd said in its earnings preview for the quarter ended December 2012 that project announcements have dropped from an already weak September quarter. Firms such as Thermax Ltd, Bhel and ABB reported a contraction in order inflow in the September quarter from a year ago. Meanwhile, industrial capex too is muted, given the slowdown and the high cost of capital. The boiler-turbine-generator segment is perhaps the worst hit in terms of profitability because of intensifying competition.
Moreover, most firms such as Voltas Ltd, Thermax and even multinationals like ABB and Siemens are struggling on execution, as clients are going slow even on the orders that have been awarded. Low revenue growth will hence have a negative bearing on the profitability of capital goods firms.
Analysts reckon that the sector has hit a trough and can only improve from these levels. However, even if ordering by the government and the private sector improves (which is unlikely for the next few quarters), heightened competition will impact margins. For a while, the appreciating Chinese yuan and duties on imports were expected to make imports more expensive, offering respite for the Indian companies. But now Chinese firms such as TBEA and Baoding are setting up significant capacity in India to make power equipment such as transformers.
All these factors make quick recovery in revenue and profit growth a distant hope, except for diversified players such as Larsen and Toubro Ltd.
Until about six months ago, the BSE capital goods index had outperformed the BSE Sensex, as a strong rebound was anticipated. However, capital goods stocks have reacted in the last couple of months on poor order inflows and news of weak execution. Also, the relatively high valuations, particularly of multinational firms, make stocks in the sector unattractive at this juncture.