Moneycontrol
May 26, 2012 12:21 PM IST | Source: Moneycontrol.com

Emkay review Engineering & Capital Goods sector

In our monthly update on the Engineering & Capital Goods (ECG) sector, starting from May 2012, we have analyzed current trends and assessed the health of the sector from multiple data points like tendering activity, order finalizations, execution and delays if any, production data and cost index.

 
 
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Emkay Global Financial Services has come out with its report on Engineering & Capital Goods space.


In our monthly update on the Engineering & Capital Goods (ECG) sector, starting from May 2012, we have analyzed current trends and assessed the health of the sector from multiple data points like tendering activity, order finalizations, execution and delays if any, production data and cost index. 


Tendering remained healthy in Apr’12 – up 11% YoY


Tendering activity held fort during Apr’12 with 11% YoY and 5% MoM increase in number of tenders opened – remaining largely steady in the last 4 months. In value terms, tenders grew 47% YoY to Rs237.5 bn, but were down 23% MoM. Roads contributed 44% of the total tenders (being key driver). Tenders by state government increased 25% YoY to 2,883. However, tenders by central government dropped 27% YoY to 603 – indicating low investment activity and a cause for concern. This benign activity could be attributed to funding constraints amidst rising deficits and policy inertia (delay in policy decisions on coal, power, telecom, mining, retail, defense, etc.). 


Order finalizations rose 39% YoY in Apr’12 – benefiting from postponement of order finalizations in Mar’12


Award issuances grew sharply by 39% YoY to Rs138.5 bn in April’12. But this offers little reason to cheer as pick-up was partially led by postponement of order finalizations from Mar’12 (Mar’12 orders down 49% yoy to Rs146.9 bn) as well as low base effect of Apr’11. Roadways and power equipments together comprised 81% of the total orders. Process, a proxy to private sector investment, continued to witness muted order finalizations (Mar’12 being the only exception in Oct’11 to Apr’12 period) and remains a cause of concern.


Production of capital goods remains strong


In high value capital goods equipment, (boilers, turbines, material handling equipment), production increased sharply in the months of Jan and Feb’12 with production trajectory on an uptrend. Production of power T&D equipment, low value capital goods equipment (engines and pumps) was also strong on YoY basis. This is attributed to execution of order backlog. However, dwindling backlog cover and higher base effect could hit growth momentum in ensuing quarters.


Emkay Cost index continues to inch up


Emkay commodity price index increased 2.0% MoM and 6.3% YoY to 208.3. Cost rise was led by crude (+16.7%) and steel (+17.3%) on YoY basis and by cement (+4.8%) on MoM basis. Prices of Aluminum decreased by 6.2% MoM and 23.1% YoY while prices of rubber fell 17.6% YoY. At 208.3, the index has surpassed its previous peak of 193.7 in Jul’08. Ex-Cement, Emkay commodity price index grew by 2.1% YoY and 1.0% on MoM basis to 218.8.


Low project additions alongside high project deletions in system, impacting visibility


Despite healthy uptick in order finalizations as well as tendering activity in April’12, we believe that visibility continues to remain bleak. This is due to continued decline in new project additions (declined for the 7th consecutive quarter – down 26% YoY) – attributed to low participation by private sector. Further, projects abandoned and shelved had no respite in store – grew 34% YoY and 75% qoq. Projects outstanding and under implementation (the barometer for asset creation) continued to witness deceleration – grew by 9.4% YoY and 9.3% YoY respectively.


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Headwinds supersede tailwinds


In a nutshell, ECG sector has multiple headwinds, which supersede any tailwinds in sight. On the headwinds, all core business catalysts are at bay i.e. an un-conducive macro environment for capex, intense competition leading to lower margins (project orders), over capacity in few product segments (power equipment), reducing visibility with dwindling order-book cover, cost index inching higher, increase in working capital cycle with higher debt and debt service charges. The only tailwind to emerge could be positive policy announcements, which could halt the deterioration.


Visibility and cashflows key to stock selection; Prefer L&T, Cummins, Greaves Cotton


Stock selection is 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 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.

Public holding more than 90% in Indian cos


Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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