It's a steady road ahead for capital goods companies in H2FY24 | Mint

It's a steady road ahead for capital goods companies in H2FY24

The EPC and HAM models were evolved to revive investment in infrastructure through government support. (Mint)
The EPC and HAM models were evolved to revive investment in infrastructure through government support. (Mint)

Summary

  • Successful order backlog execution, and steady commodity prices may boost earnings for capital goods companies

Most capital goods, engineering, and infrastructure companies have seen a sharp rise in their share prices in 2023, with the sectoral index surging 46% so far this year. This is primarily due to the government's focus on infrastructure development in the run-up to the general elections.

The increased focus on government-backed capital expenditure, primarily directed towards sectors like railways, power, and defence, has spurred investor interest and fuelled optimism in these industries.

Not surprising that foreign portfolio investors have also shown a keen interest in capital goods companies amid the current scenario. As per the data on institutional flows in October, foreign portfolio investors have bought more shares of industrials, while there was a significant selling in shares of financials, according to a note by ICICI Securities on 22 November.

Capital goods companies are expected to maintain stable revenue growth in the second half of FY24 due to successful order backlog execution, while steady commodity prices may boost earnings.

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Sector bellwether Larsen & Toubro Ltd (L&T) received orders worth 89,153 crore in the September quarter (Q2FY24), up 72% year-on-year. L&T’s order prospects pipeline as of September 2023 also looks strong at 8.8 trillion. The engineering, procurement and construction major expects to surpass its order inflow target of 10-12% and revenue growth forecast of 12-15% for FY24.

Some analysts believe around 60% of L&T’s order book is yet to reach the margin threshold stage, which means improvement in profitability could be gradual.

During Q2, ABB India, Cummins, and Thermax saw an increase in operating margin due to premium product mix, operating leverage, and normalized commodity prices.

“Higher margins should sustain (for product companies), possibly even seeing slight improvements in the future due to sustained demand and a decrease in commodity inflation," said Parikshit Kandpal, analyst at HDFC Securities. “However, a key consideration is whether companies can successfully pass on price increases to customers or roll back those hikes," he added.

Some companies may face challenges in exporting due to a potential decrease in capital expenditure by customers amid a global recession and geopolitical tensions. Besides, volatility in raw material costs and the upcoming general elections in India could disrupt the supply chain, and hinder the current pace of order placement, especially in the near term.

Some infrastructure companies are facing a challenging outlook. Tendering for road projects has remained weak, with awarding pushed to the second half of the year. According to Antique Stock Broking, project tendering activities from April to October were flat year-on-year at 7.3 trillion. New project announcements in October were down 37% to 87,300 crore.

Also, NHAI’s awarding activity has been slow in the first half of FY24. Against this backdrop, KNR Constructions has cut its order inflow guidance in FY24 to 3,000-4,000 crore from 4,000–5,000 crore earlier. At the same time, PNC Infratech has retained its FY24 order inflow growth guidance of 10-15%, and still expects up to Rs10,000 crore worth of new orders in the current fiscal.

“On account of healthy execution in the absence of new orders meant the book-to-bill visibility declined to 2.8 times during the quarter vs 3 times at end-Q1FY24," said Elara Securities, commenting on the September quarter performance of infrastructure companies. Book-to-bill ratio reflects demand for closing orders.

The project awarding was delayed due to the government's strict policy of ensuring that all clearances, including land acquisition, are in place before awarding. It is expected that awarding activity will improve in the second half of FY24. To ensure revenue visibility beyond FY25, it is crucial for road construction companies to secure new projects in the medium term, along with better execution.

 

 

 

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