For the January-March 2009 quarter, we estimate the capital goods companies under the Sharekhan’s universe to report a 25.3% revenue growth on the back of strong executions, particularly by larger players—Bharat Heavy Electricals Ltd (BHEL) and Larsen & Toubro (L&T).
However, for the mid- and small-sized players, the growth is expected to moderate significantly due to lower order flows and execution road blocks.
On the operating front, while the prices of key raw materials have eased significantly during the past couple of quarters (with the base metal prices cooling off from their peaks) any positive impact of the same on the earnings of the companies may not happen immediately in our view and are likely to flow in from Q1FY2010.
Further, the extent of benefits would also depend upon the nature of contracts (fixed and variable prices) and inventory levels of the materials held by the company.
We expect the profits of the companies under our coverage to grow at 8.3%, as lower operating margins and high interest cost (due to elongated working capital cycle) would limit the profit growth (in spite of healthy top line growth) of the companies.
Capital expenditure plans
One of the major concerns that dragged the capital goods sector’s companies has been the slowdown in the private capital expenditure (capex) and the consequent stress on the order inflows.
While the orders have been slowing, the current quarter saw poor flows particularly for the mid- and small-sized companies. On the other hand, the heavyweights—BHEL and L&T continued to report strong order inflows.
For the companies in the power transmission & distribution (T&D) space, orders are picking up, as tendering activity for Power Grid Corporation of India Ltd (PGCIL) orders gathers pace.
From our universe, Crompton Greaves Ltd (CGL) is likely to be the key beneficiary of the orders from PGCIL.
Going forward, we believe the concerns of funding, execution delays and further cuts in the private capex would continue to remain the primary concerns for the sector and the future performance of the companies.
The moderation in the index of industrial production (IIP) to 3% in the first 10 months (down from 8.6% in the corresponding period of the last fiscal) and a relatively flattish capital good component of IIP indicate towards the on-going moderation.
On the other hand, a healthy pick-up in the cement and steel off-take provides some comfort in terms of enhanced government spending on infrastructure projects.
Accordingly, the companies with higher exposure to government spending are better placed than ones dependent on industrial and consumer business. Our top picks in the space are BHEL (enter at lower levels), CGL and Sanghvi Movers.