Emkay Global Financial Services has come out with its report on engineering and capital goods monthly update for February 2013. According to the research firm, stock selection should be purely driven by visibility, cash flows and ROIC of the business models.
Emkay Global Financial Services has come out with its report on engineering and capital goods monthly update for February 2013. According to the research firm, stock selection should be purely driven by visibility, cash flows and ROIC of the business models. Few companies appear to be richly valued. Larsen & Toubro, Cummins India, Greaves Cotton and Blue Star are few top picks in the ECG sector, says Emkay.
Indian Machine Tools Industry
- The domestic Machine Tools (MT) industry is Rs118 bn in size and has witnessed 14% CAGR during FY08-12 period
- Key players in the listed space include HMT, Kennametal India, LMW, Birla Precision Technologies, Lokesh Machines
- The MT industry has strong growth drivers for the next 2-3 years
Macro economic indicators - The MT industry has high correlation with overall macro conditions. The correlations stand at 3X IIP, 2X GCF and 3X GDP growth rate – as witnessed empirically.
User industries have favourable base effect – Demand for auto industry (contributing +40% of total demand) is expected to pick-up to +10% in FY14E and further by +15% in FY15E (Vs 5% in FY13E)
Emergence of new sectors – Emerging areas include aviation, defence, railways, power and heavy engineering
As per IMTMA, the domestic MT industry is expected to grow at a 15% CAGR during FY12-17E period.
But we believe that investment opportunities are limited in the domestic MT industry in view of high fragmentation, competition, high import raw material content (at 30-50% of total cost) and a 26.5% import duty
However, we believe that Kennametal India is favourably placed. This is in view of (1) Strong parent in global leader Kennametal Inc (2) Already present in the emerging sectors (3) To benefit from revival in automotive industry – contributes 64% of revenues. Besides Kennametal India is amongst the few players which has a clean balance sheet, has generated average annual free cash flow of Rs350 mn during FY09-12 period and robust return ratios - ROCE at 32% and ROE at 23%.
Key trends observed during the month
After a drop in Dec'12, tendering activity picked up again in Jan'13 – up 35% MoM and 98% YoY to Rs304 bn. Importantly, number of tenders continue to trend up – increased by 7% MoM to 4630 tenders – the highest ever.
Order announcements were lower for the month of Jan'13 – down 5% YoY and 34% MoM to Rs110 bn – though at par with the YTD FY13 monthly average but significantly lower than the long term average of Rs163 bn.
Sectorally, a tender in roadways has been on a down-trend for the past 5 months, while railways has reported strong tendering activity. Correspondingly, order announcements for the month of Jan'13 were driven by railways (38% of total) while roadways witnessed muted announcements (1% of total).
Increased activity in the railways is attributed to opening & finalization of tenders for various metros as well as in the western dedicated freight corridor (DFC).
Production data of capital goods equipment was largely declining in Dec'12. Barring for low value capital goods equipments & consumables, all other categories witnessed decline in production, namely, high value capital goods equipment, power T&D equipment and construction equipment – both on YoY basis as well as MoM basis.
Emkay Commodity Price Index (ECPI) at 196.1 in Jan'13 - remains range bound between 195 to 200 levels.
Credit to infrastructure grew by 16% YoY to Rs6.92 tn (up 0.5% MoM). Credit to power grew by +20% for the second consecutive month – indicative of pick-up in execution of power projects.
ECG sector continues to trade in a narrow range of 14-15X 1-year forward PER. Though premium to Sensex has disappeared after the 7% price correction in the past one month
Institutional investors (II) continue to have low preference for the ECG sector – remained under-weight. Though Engineering Structurals witnessed sequential rise in holdings – this was largely led by increase in holdings by Foreign institutional investors. At the company level, IIs sequentially increased their share holding in IVRCL (+900 bps), JP Associates (+120 bps), NCC (+230 bps), IRB Infrastructure (+110 bps).
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 (3) Greaves Cotton and (4) Blue Star.
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 Rs1700/Share.
Cummins India - Technology intensive business model with near-term earnings catalysts and ROIC of +40%. We have Accumulate rating with price target of Rs570/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 Rs100/Share.
Blue Star - We expect BLSR's strategy to pursue profitability over growth and expect it to reap rich dividends going forward. Positive catalysts gaining prominence. We have Buy rating with price target of Rs215 per share.
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