Emkay Global Financial Services has come out with its report on engineering & capital goods space.
Statistically, we ascribe low probability to sharp cuts in earnings estimates:
We have statistically analyzed change in consensus earnings estimates and our key findings are as follows:
The ECG sector has witnessed sharp cut in earnings estimates over the past 18 months with FY13E consensus earnings estimates witnessing a 25.4% cut since Jan’11. Corresponding earnings growth over FY12 has also come down from 15.6% in Jun’11 to 6.8% in Jun’12.
We have observed highest earnings cut in power companies (-24.3%) and non-EPC companies (-21.6%)
Downgrade in FY13E earnings estimates was largely led by cut in EBITDA margin assumptions. FY13E EBITDA margins have been downgraded by 130 bps to 12.9% in Jun’12
Some positive trends have emerged (1) deceleration in earnings estimates downgrades- FY13E earnings estimates cut by only 4.0% in Q1FY13 Vs 7.5% in Q4FY12 and 7.6% in Q3FY12 (2) Improved outlook for FY14E- extent of contraction in EBITDA margins reduced from 340 bps in Jan’11 to 290 bps in Jun’11 to 200 bps as on Jun’12.
Statistically, we draw strength from the slowdown in downgrades in earnings forecasts and the historical trend of minimal cuts in the second half. Going forward, we do not expect sharp cuts in earnings estimates. Believe most negatives are priced in
Key trends observed during the month:
For the month of June’12, tendering activity broke the range of 3,300-3,500 and created a new high since Jan’11. Number of tenders grew 84% YoY to 3,877 (up 18% MoM). However, in value terms, it declined 1% YoY and 16% MoM to Rs232.9 bn.
The road sector remained the highest contributor with 1,557 or 40% tenders opened during the month. This was followed by community services (624, 16%), water supply (363, 9%), irrigation (264, 7%), railways (263, 7%), power distribution (128, 3%) and power equipment (106, 3%).
Value of orders announced declined sharply by 54% MoM to Rs51.8 bn. This sharp drop in orders was witnessed across all sectors except for Power Distribution. Roadways continued to decline (down 68% MoM to Rs1.5 bn, after 92% MoM decline last month). Orders from Power Equipments also declined by 78% to Rs17.1 bn.
The ECG sector witnessed strong growth in production, albeit on a low base in Apr’11. All equipments witnessed strong growth, except for gears, which saw a decline.
After consecutively rising in the past one year, Emkay cost indices declined 2.1% MoM in Jun’12 (though up 5.8% YoY).
Quarterly project additions declined for the 8th consecutive quarter (down 36% YoY) while deletions remained high (up 18% YoY and 29% QoQ). Led by central & private sector projects, deceleration in projects outstanding and under implementation continued in quarter ending Jun’12. Mining and Irrigation were the only two sectors, which witnessed YoY growth in projects under implementation.
Top picks from EMKAY ECG universe: 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.
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 Rs460/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 Rs90/Share.
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