Emkay Global Financial Services has come out with its report on capital goods space. Larsen & Toubro (L&T), Cummins India and Greaves Cotton are the top picks in the space.
In this month’s update on the Engineering & Capital Goods (ECG) sector, we have analyzed power projects effected by Coalgate issue along with our usual assessment of tracking trends in project tenders, project awarding, production statistics, etc.
Update on Havells dealer Roadshow:
Key trends observed during the month:
- Havells works on a purely distribution/dealer driven business model with consumer centric products sold through a three-layer Company-Distributor-Dealer channel, while industrial products are sold through two-layer Company-Dealer channel.
- Dealers work on competitive margins ranging from 3-7% with lighting having high margins of 7%, while, industrial switchgears and cables offer only 3% margins. Havells has built strong relations with dealers/distributors by managing the softer aspects of business.
- Advertising has been the key differentiator for Havells vs competition. In addition, Strong brand lineage of “Havells”, rising distribution network (5600+) along with its own manufacturing with strong support service have led to sustainable and faster than industry growth for Havells.
- Havells product prices are inline with domestic players, but cheaper by 10-15% than MNC players. However, Havells growth story is not a derivative of price-led competition
- In the current state of affairs, consumer demand has been slow since September 2012. Growth has dipped significantly to 0-5% vs 20% in previous quarter. Moreover, growth has been price-led, while volumes have been sluggish. Market is witnessing increasing competition with recognized brands venturing into products categories like switches, lighting, CFL, etc.
Top picks from EMKAY ECG universe:
- After a spike in tendering activity witnessed in Sep’12, tendering activity reverted back to normal levels (in line with average tendering activity of past few months). In Oct’12, number of tenders published stood at 3,255 tenders down 23% MoM but up 94% YoY (on low base). In value terms, tenders published grew by 8% MoM to Rs276 bn (up 171% YoY).
- Sector-wise, roadways, community service, irrigation and real estate witnessed MoM drop in tendering activity in Oct’12 comes after strong activity in Sep’12, but remained at healthy levels. Railways and power equipment witnessed healthy growth in number of tenders sequentially.
- Order finalizations declined sharply during Oct’12 down 43% MoM and 59% YoY to Rs50.6 bn (lowest in past 4 years). Weakness in order finalizations was witnessed across sectors, barring for few sectors like power distribution, real estate and process industries.
- Production of capital goods equipment largely declined on YoY basis during Sep’12, though sequentially it was stable or down-trending in most cases. This was observed in case of high value capital goods equipment, power T&D equipment and construction equipment. In case of low value capital goods equipment, production trend was mixed, but largely uptrending.
- Emkay Commodity Price Index appears to have plateaued at 195 levels - in Oct’12, Emkay commodity price index declined by 0.4% MoM to 195 (up by 1.8% YoY).
- A look at the sectoral holdings of institutional investors (IIs) reveals no change in sector preferences. IIs have retained their sectoral allocations / weights with no sector emerging as a clear preferred choice. The ECG sector remains under-weight Vs BSE-200 index, though engineering structurals sequentially witnessed some increase in holding.
- Absolute ‘Sell’ ratings surpassed ‘Buy’ ratings as given by Sell side analysts - first time in history… reflective of downbeat continued outlook.
- Cut in consensus earnings estimates was marginal at 0.8% during Oct’12 for FY13E while there was no change in consensus earnings estimates of FY14E. Cut in estimates has remained less than 1% for the past few months.
We maintain that stock selection should be purely driven by visibility, cash flows and ROIC of the business models. Few companies appear to be richly valued (on relative basis). These should be viewed in conjunction to strength of the business model. Our top picks in the ECG sector are (1) Larsen & Toubro (2) Cummins India and (3) Greaves Cotton.
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- Larsen & Toubro - Strong order book cover with diversified business model and top quartile earnings growth amongst peers. We have Accumulate rating with price target of Rs1603/Share.
- Cummins India Technology intensive business model with near-term earnings catalysts and ROIC of +40%. We have Accumulate rating with price target of Rs500/Share.
- Greaves Cotton Though we expect muted earnings growth in near term, FCF yield of 8% gives reasonable comfort. We have BUY rating with price target of Rs80/Share.