Capital goods: What to look for in Q4 results
The gain in the BSE Capital Goods index is around two-and-a-half times that of the Sensex. While this may be driven by optimism about the green shoots of recovery in the economy, it does not necessarily imply a stellar March quarter (fourth quarter or Q4) show by capital goods firms.
Results are likely to be chequered, though the low base created by poor growth in the last six quarters may prove beneficial for most firms in the sector. Therefore, investors could do well by looking out for the following pointers in the results:
First, the key to earnings growth sustenance is healthy order inflow. Firms with higher dependence on government orders would be better off as there is more action in sectors like renewable energy, power transmission, railways and roads, and a few private sector industries. Large-sized, diversified companies like Larsen and Toubro Ltd, Engineers India Ltd, and project firms like Blue Star Ltd, KEC International and ABB India Ltd would report decent order inflows for the quarter.
But then, those with higher exposure to private sector industries and exports like Thermax Ltd and Cummins India Ltd may be stressed for order inflows, as domestic consumption demand and the global economic milieu are yet to bounce back.
On the whole, the March quarter maybe more optimistic with flat or a single-digit growth in order intake compared to contraction over the last several quarters. Huge order backlog too must be analysed in the context of the pace of execution and also whether it includes any stranded projects. For instance, a significant portion of Bharat Heavy Electrical Ltd’s (Bhel’s) order book looks doubtful.
Second, brokerage firms forecast a 10-12% revenue growth. Again, investors must analyse whether the growth in revenue is a result of execution that was pending for many months and lumped up in March. If so, will it sustain? Firms catering to public sector projects would fare well as the government is trying to speed up clearances and move stuck projects.
For the March quarter therefore, revenue growth may be erratic across firms. Those servicing the industrial sector may lag in revenue growth. Even global companies have been in a quandary for almost 8-10 quarters. Profit growth too is likely to follow a similar pattern. Expect outperformance from Bhel, on the strength of a low base, execution ramp-up and perhaps lower expenses.
Three, it is important to focus on the management commentary that will highlight prospects for the next year along with challenges and risks. For instance, a stronger rupee (as seen now) could have repercussions for capital goods exporting firms like Coal India Ltd and ABB India. Higher commodity prices may drag operating margins down by a few percentage points.
Further, management commentary on the global economy, mainly the West Asian market, which is quite significant for capital goods exporters, will be important. A report by Motilal Oswal Securities Ltd says that there was a revival in activity in the region in spite of low crude oil prices.
Investors must look for signs of improving domestic consumption demand and capacity utilization that will drive further investments into fresh capacity. Data from the Centre for Monitoring Indian Economy shows an increase in investment proposals in the March quarter, higher than the average of the preceding 10 quarters. However, it may take a while for these to translate into robust and steady growth in order inflows.
For now, valuations especially those of multinational firms have raced ahead of earnings growth. Capital goods stock trade anywhere between 15-45 times one-year forward estimated earnings. Hence, any disappointment in earnings during the March quarter will puncture the rally in stock prices.