Since July, the BSE Capital Goods index has fallen 14.6%, compared to a 7.6% fall in the BSE 500 index. Valuations of the sector took a hit, with weakening macroeconomic indicators eroding hopes of a sustained recovery.
In a September report, analysts at Motilal Oswal Financial Services Ltd said that the capital goods sector trades at a one-year forward price-to-earnings multiple of 21 times, which is at a discount of 22% to the 10-year average of 27 times.
The sector’s valuations had improved in the first six months of FY19 on the back of strong public sector spends and also a pickup in private sector orders.
However, things changed dramatically from the second half of FY19. The initial green shoots of recovery seen about a year ago dried up, following the liquidity crisis in the domestic economy. It continued with a slowdown in order flows for capital goods companies in the run up to the general election. Order flows for large capital goods firms, such as ABB India Ltd and Siemens Ltd, were nothing to write home about in the June quarter.
That said, hopes of a recovery during FY20 began to recede with the gross domestic product growth inching lower and the slowdown bug biting more and more sectors.
M.S. Unnikrishnan, managing director and chief executive officer of Thermax Ltd, says: “With industries, such as fast moving consumer durables, auto and construction, facing sales drop, demand contraction and job losses, capacity expansions are unlikely."
Analysts echo a similar sentiment, too. Unless capacity utilization across retail and consumer industries improves to 80-85%, it is unlikely that the capital goods sector will see healthy order flows.
“It would take anywhere between 18-24 months for order traction in the capital goods sector," says Unnikrishnan.
To be sure, there would have been marginal orders in the June quarter from public sector firms, as has been the case for many quarters, before the general election.
However, a report from UBS Securities India Pvt. Ltd points out that government expenditure growth also decelerated to 8.8% year-on-year in the June quarter, from 13.1% year-on-year in the March quarter.
With the political and economic turmoil in international markets, export orders, too, fell for most firms. Further, the increase in competitive intensity may hurt profitability.
Hence, the drop in valuations is not surprising. Only Voltas Ltd, Havells India Ltd and Solar Industries India Ltd, which have bucked the trend in the last few quarters, trade at premium valuations compared to their decadal average. “Even on the price-to-book basis, the sector trades at a discount of 19% to its 10-year average multiple of 3.3 times," adds the Motilal Oswal report.
Until order flows pick up, capital goods stocks, too, could remain under pressure.
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