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June quarter earningsindicate the road to recovery would be painfully slow. (Photo: Pradeep Gaur/Mint)
June quarter earningsindicate the road to recovery would be painfully slow. (Photo: Pradeep Gaur/Mint)

Subdued govt capex may leave investors in capital goods sector in despair

The government’s tight fiscal space makes it challenging to boost infrastructure spending amid the pandemic crisis. Also, increased focus on cash conservation has delayed private capex revival

The S&P BSE Capital Goods index has rallied by 12% in the past month. Expectations of an infrastructure revival package by the government could be a reason for this optimism. This is more so as recently some members of the prime minister’s Economic Advisory Council have been rooting for a massive infrastructure stimulus.

Even so, despite the recent jump, the BSE Capital Goods index is almost 20% lower than its pre-covid high of 17,726.61 in January. The government’s tight fiscal space makes it challenging to boost infrastructure spending during this pandemic crisis, analysts said. Increased focus on cash conservation has further delayed private capex revival. These factors make the capital goods sector’s growth prospects unappealing.

India’s capacity to support high levels of debt is constrained by its ability to raise revenues, according to an analysis of India’s fiscal stress done by Emkay Global Financial Services Ltd. “We estimate India’s debt/revenues to reach/exceed about five times by FY23E, which was last witnessed in FY03 when the sovereign rating was junk," it said in a report on 18 August.

India’s debt/revenue is at about four times and the debt overhang is not transient, and may haunt until fiscal year 2025, according to Emkay. As such, the brokerage house expects infrastructure spending to stagnate. A double whammy of lower tax collections and reduced revenue allocation from the Centre, would also keep infra spending by states muted. Thus, counter-cyclical spending on infrastructure may not be able to bail out the economy from the pain.

High fisical stress
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High fisical stress

June quarter earnings also indicate the road to recovery would be painfully slow. Management commentaries highlight challenges on order inflows and execution. The ABB India Ltd management told analysts that uncertainty is expected to continue on the demand front for next two quarters amid possible order cancellation.

Further, analysts at Motilal Oswal Financial Services Ltd caution of an elongation in working capital cycles for the sector because of payment delays and extended support measures to vendors. Staggered return of labour is another challenge.

Meanwhile, valuations may seem relatively cheap compared to historic averages at a time when a meaningful earnings revival is still away. According to Bloomberg data, shares of key capital goods companies are trading at a price-to-earnings multiple range of 13-33 times, based on estimated FY22 earnings.

“Obviously the impact on visibility of earnings and elongated recovery cycle to FY22 will keep these capped," said Dolat Capital Market Pvt. Ltd analysts, commenting on valuations of EPC companies in its coverage universe. “We do not see any lead signals for higher visibility over the next couple of quarters at the least," said the broking firm in a report on 17 August.

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