Home / Market / Mark-to-market /  Low capacity utilization still a concern

Some analysts and investors may be enthused about the prospect of earnings upgrades after the March quarter results, given that it is expected to be the third successive quarter of double-digit growth. But clearly there are reasons to be cautious. For one, there is no sign yet of a revival in the investment cycle.

Capacity utilization in core sectors has been declining in the past few years, based on data collated by Crisil Research. For example, utilization in the cement sector, which saw huge capacity additions in the last few years, dropped from 77% in financial year 2010-11 to 70% in 2012-13. Worse still, it is expected to drop further in the next two years. The scenario is worse in the power sector, which is plagued with policy hurdles. Utilization is expected to drop to 67% in 2014-15 from 70% in 2012-13 and 75% in 2010-11.

The problem of surplus capacity in core sector industries is a trickle-down effect of poor demand. Sales of consumer goods such as cars have been sluggish and the scenario is expected to continue. As a result, capacity utilization in these sectors is likely to drop.

Weak utilization delays the recovery in the investment cycle. Another dampener is falling return on investment. High interest rates and the reluctance of the financial sector to sanction loans to capital-intensive projects could deter companies from undertaking capital expenditure. “Investment in capacity building at a sector level will be limited over the next one year, until demand recovers," says Rahul Prithiani, director, Crisil Research. High utilization rates with some sectors touching 100% utilization was perhaps last seen in fiscal year 2006-07, after which capacity additions had gained momentum.

A Kotak Institutional Equities report indicates that the silence of major political parties on economic issues like fuel subsidy, and environmental and project clearances is disappointing. Hence, business confidence indicators, which influence capital expenditure, will hinge on action by the new government after the elections.

Indeed, some sectors have managed to sustain profitability through stringent internal measures like cost-cutting and the sale of non-core assets to generate cash flows. While some investors might be pleased with the earnings growth, companies are likely to wait for utilization rates to improve before committing to capacity building.

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