The return of brownfield investments
The December quarter earnings of capital goods firms, while unexciting in general, have one silver lining: the return of non-greenfield investments. Commentaries and order win trends from ABB India Ltd, Siemens Ltd and Thermax Ltd show that brownfield investments relating to de-bottlenecking, augmentation of existing capacities and efficiency improvement spends are emerging as notable order inflow drivers.
ABB India, for instance, reported a 43.7% rise in order inflows last quarter, adjusted for an unusual project win in the year-ago period. The inflows are largely driven by the above mentioned factors or the operating expenditure (opex) related spends. “ABB highlighted that companies are still not significantly incurring capex, though (it) continues to benefit from opex spend directed towards increasing productivity and reliability with increasing automation,” Edelweiss Securities Ltd said in a note. Capex is short for capital expenditure.
In comparison, order inflows at Siemens increased just 2% but the company ended the quarter with a record order book. According to IDBI Capital Markets and Securities Ltd, Siemens expects digitization of manufacturing plants to be the revenue driver. Prospects are increasingly seen in non-cyclical segments like pharmaceuticals, food and beverages, and packaging. Thermax reported a strong 19% rise in order inflows, driven by waste heat recovery and pollution control orders. Further, the management sees positive momentum in order inflows barring the power sector.
“Management sees green shoots in the domestic market across sectors, barring the power sector,” Sharekhan Ltd said in a note. “Management expects uptick in orders from the cement, oil and gas, steel, bulk chemicals, fertilizers and consumption segments (such as food, food processing, textile and beverages).”
Overall, even as the core industries are yet to re-enter the capex phase, companies are seeing green shoots in certain segments, notably the infrastructure sector driven by the government, and capacity and efficiency improvement expenditure by the private sector. However, the question investors need to ask is: will this be sufficient to drive earnings growth? Maybe not.
Companies such as ABB India and Siemens would need an annual order intake in excess of Rs13,000 crore in the base case for them to deliver notable earnings growth, says Rohit Natarajan, analyst at IDBI Capital. In contrast, ABB India booked orders worth Rs9,490 crore in 2017. Of course, the Rs13,000 crore number is not sacrosanct. “For instance, these companies can book orders in excess of Rs15,000 crore at the cost of margins or book a lower figure than Rs11,000 crore and yet make higher margins,” reasons Natarajan.
Still, the key to earnings remains order inflows which have to pick up further. The second factor is profitability. The rise in raw material prices and limited orders are leading to more competition. Unless the ordering activity gathers pace, margins may remain suppressed, weighing on earnings of the companies.