Since early July, when companies started announcing their June quarter results, the BSE Capital Goods index has fallen 17.01%. This is far steeper than the 7.42% drop in the benchmark BSE 500 index and some of the other sectoral indices.
What disappointed the Street was the drop in revenue growth and profitability during the quarter.
The mere single-digit growth in revenue was mainly on account of slow progress in execution of projects. A report by ICICI Securities Ltd shows that revenues of 15 companies under its coverage grew by a paltry 5.5% year-on-year. Excluding the largest capital goods conglomerate, Larsen and Toubro Ltd, revenue growth was flattish at 0.3%.
On the whole, the performance was checkered. Companies with short-cycle orders in food processing or automation in sectors such as cement fared better than those with large projects in the power sector. For instance, in spite of its huge order book of ₹1 trillion, Bharat Heavy Electricals Ltd’s revenue contracted by 24% year-on-year on account of land-acquisition issues in some of its projects. On the other hand, Thermax Ltd beat the Street’s forecast with a revenue growth of 35% year-on-year, while Cummins India Ltd with multinational parentage posted a tepid 1% growth.
Weak revenue mars profit expansion, simply because fixed costs weigh on margins. Although raw material costs did not soar in absolute terms, weak capacity utilization and operating leverage impacted profitability in the June quarter. The same was true for employee costs as well.
Not surprisingly, therefore, Ebitda (earnings before interest, tax, depreciation and amortization) growth was below forecasts for most companies. Ebitda margin contracted year-on-year in most cases by 100-400 basis points, with a handful showing marginal growth.
Meanwhile, the slowdown in the economy is getting worrisome. There has been no increase in new orders after the general election. Even so, there is some hope that the government outlay towards infrastructure will offset the weakness in private sector capital expenditure (capex). While some companies bagged overseas orders, with the turmoil in global markets increasing, these too may be at risk.
On the home ground, a series of interest rate cuts has failed to kickstart investment in consumption and capex. According to Motilal Oswal Financial Services Ltd, “Liquidity continues to be low and may impact execution in case the problem persists. Working capital towards execution increased, as companies opted to support their vendors in a tight liquidity scenario."
Little wonder then that the shares of capital goods firms, which rose in early 2019, have shed all the gains in the last two months. Even so, most companies trade at rich valuations between 15 and even 40 times estimated FY20 earnings. Things will improve only with a broad-based improvement in consumption and investment cycle.