Capital Goods sector Q3FY13 earning estimates: MOSt

Motilal Oswal has come with its December quarterly earning estimates for capital goods sector. According to the research firm, capital goods universe is expected to continue moderation in revenue growth in 3QFY13, impacted by depleting order book and execution constraints.

Motilal Oswal Q3FY13 result preview for capital goods sector:

We expect continued moderation in revenue growth in 3QFY13 (up 7% YoY v/s 11% YoY in 1HFY13), impacted by depleting order book and execution constraints. Ordering activity remains sluggish, particularly in the industrial / power generation segment. Ordering by Power Grid Corporation (PGCIL) has also been muted during 3QFY13. BTB continues to show a declining trend after peaking out in 2QFY11 and currently stands at 2.3x, the lowest in 19 quarters. In 3QFY13, we expect EBITDA margin at 12.3%, down 80bp YoY, impacted by poor fixed cost absorption. While commodity prices have corrected meaningfully, a large part of the decline is negated by currency movements. Companies with high local manufacturing content (like BHEL, Cummins and Thermax) will be the key beneficiaries.

Environment remains challenging; sentiment has improved

Net bank credit to the Infrastructure sector is declining since June 2011 and has reached FY09 levels. Quarterly run rate of project sanctions has reached INR250b-270b v/s a peak of INR1,250b in 1QFY11. This indicates accentuating slowdown in Industrial and Infrastructure spending. Trailing twelve month (TTM) net projects added per quarter have shown a continuous decline after peaking out in March 2009. Our interactions with several companies suggest improved sentiment and improved order enquiries; however, conversion into concrete ordering is yet to be seen. Structural issues like SEB finances (for power sector), land/water/environment clearances, and tight liquidity remain challenges for capex upturn. The government is attempting to address these issues.

Initial rays of hope, but near-term concerns impact valuations

Our Capital Goods Universe trades at 15x FY14E EPS (20% discount to long-term average of 18x). The premium relative to the Sensex enjoyed by our Capital Goods Universe has significantly eroded over the past two years. It now trades at a 4% discount to the Sensex v/s the long-term average premium of 17%. We expect flat earnings CAGR over FY12-15 for our Capital Goods Universe. The government's resolve to address the contentious issues in the Power sector, close monitoring of the PSU capex, take-off of large public expenditure projects (like DFCC, railways, urban transport, etc) can possibly kick-start the investment cycle. Decline in commodity prices and RBI's recent CRR cuts on the back of easing inflation provide another ray of hope. We are Neutral on the sector; our top picks are L&T, Cummins and Crompton Greaves.

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