Confidence waning, capital goods sector in limbo

Confidence waning, capital goods sector in limbo

By now, most equity research houses have lowered current year estimates for India’s gross domestic product and corporate earnings growth. The June quarter showed a slowdown in economic activity across sectors. A Morgan Stanley Asia Research report, “India Corporate Survey: Capex Caution but Hiring Hails", says that for a second consecutive year, corporate India is unlikely to raise capital spending by much in the current fiscal. Confidence in growth, which is critical for capex, appears to have waned.

Mirroring this is the slowdown in fresh order inflows, which for the June quarter was lower than in the year earlier. The main reason was sluggish ordering by the power sector. A report on capital goods by Prabhudas Lilladher Pvt. Ltd says, “Average new project announcements per quarter remained at 3 trillion for the last three quarters against an average of 4.2 trillion per quarter in 2010."

Barring ABB Ltd and Siemens Ltd whose order inflows improved, even leaders such as Bharat Heavy Electricals Ltd registered flat growth.

Meanwhile, the sector disappointed on performance, too; delays by clients, unrest in West Asia and European uncertainties hit execution. On revenue growth, firms such as Crompton Greaves Ltd and Voltas Ltd threw up negative surprises, while Thermax Ltd was positive during the June quarter. Operating margin, with lower leverage and rising costs, dipped by around 100 basis points (bps) from the year before. One basis point is one-hundredth of a percentage point.

Thanks to a 175 bps increase in the prime lending rate in the last three quarters, interest costs dragged net profit down. Although higher than the year before quarter, it fell short of analysts’ expectations. That said, the last fortnight saw an uptick in the performance of the capital goods stocks. The moot question is whether a reversal is in sight. A report by Elara Securities Ltd through a historical trend analysis says that the current peak-to-trough cycle should last around 5.5 quarters. The last recessionary phase lasted five quarters, beginning fourth quarter of fiscal 2008 and ending in the first quarter of 2010. The last peak being in the second quarter of fiscal 2011, we should hit the trough in the third quarter of fiscal 2012.

This seems to coincide with the improvement in order inflows in the second half of fiscal 2012, which the Street anticipates. Right now, concerns are high on sticky inflation and fuel prices retarding capex, while damage from interest rates could be felt with a lag effect in the ensuing quarters on corporate profitability. Besides, reports state that the government investment fell by 35% year-on-year from January to June this year. The ratio of revenue generated to capital employed has touched a decadal low.

One positive is that barring some sectors such as cement, which is reeling under oversupply, demand consumption in domestic markets is expected to drive capacity addition in sectors such as auto and manufacturing.

Will the softening commodity prices and the resultant tempering of inflation ensure this? The Street is waiting for positive cues from the government on policy action in infrastructure to kick-start the investment cycle.

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