The most striking feature of the Index of Industrial Production (IIP) numbers for January released on Friday was the 56.2% year-on-year rise in capital goods. That was on top of a 15.9% rise in January 2009, so you can’t say this was due to a base effect. The capital goods numbers are volatile but a look at the chart shows that growth has been accelerating steadily since October 2009. Economists have almost uniformly pointed to these numbers as a signal of rising investment demand.
Intriguingly, the data had no impact whatsoever on the Sensex, which closed flat on Friday, while the BSE Capital Goods index was one of the worst performers. In fact, the BSE CG index has underperformed the Sensex this year.
But broking house Motilal Oswal Securities Ltd says there’s a strong correlation between revenue growth of capital goods companies and the IIP’s capital goods index. It points out in a report that, “Since 2007, IIP growth was led by capital goods, which averaged growth rates of 2-3x the growth rate of the IIP, indicating a strong capex cycle.” But so far, despite the pickup in the capital goods segment of IIP from October, the BSE’s capital goods index has more or less tracked the Sensex.
Also See | Rising Capital Expenditure (Graphic)
One reason is that while IIP measures production, the market is interested in corporate earnings. And rising input prices, a bigger wage bill and higher interest rates will squeeze margins, ensuring that profit growth is more muted than the rise in revenue.
Could it be that the growth of investment demand is already priced in? Well, as on last Friday, the trailing price-earnings multiple for the BSE Capital Goods index was a very high 28.8, compared with the Sensex’s 20.9. Here’s what the Motilal Oswal report has to say: “Given that margins are near historical peaks and moderate savings expected in terms of lower interest, depreciation (as a percentage of revenue), we expect earnings growth to be in line with revenue growth. Hence, there are limited possibilities of large earnings surprises... Given these parameters, we believe current valuations already factor in a cyclical upturn.” That’s the reason why the markets reacted far more calmly than the economists to the IIP data.
Graphic by Yogesh Kumar/Mint
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