Macquarie wary of Crompton & BHEL, bullish on L&T

Shares of Crompton Greaves fell sharply in the morning trade after the company's net profit in the Jan-March quarter shrank as much as 75 percent. Speaking on the company's internals, Inderjeet Singh Bhatia of Macquarie Capital Securities told CNBC-TV18 that Crompton’s domestic business is of a bigger concern now.

Macquarie has cut Crompton's FY EPS estimate by 14 percent and target price to Rs 83 per share from Rs 85 per share. He sees the company's standalone margin at around 8 percent while that of its subsidiaries at 1 percent. Speaking about engineering major BHEL, Bhatia said the company's structural pain may warrant a margin fall and advised investors to saty away from the stock. On Larsen and Toubro, Bhatia said the company reported an improvement in its working capital cycle and its order inflows and guidance were heartening. Macquarie remains wary of the capital goods space which has disappointed on the margins front in the Jan-March quarter. Order Inflows too have been muted during the quarter. Below is the edited transcript of his interview to CNBC-TV18 Q: It does not look like a good quarter for your sector again. Let me start off with Crompton Greaves. What you have made of the numbers; are you guys are scaling back expectations even more? A: We have been negative on Crompton Greaves for sometime. I would say the market has been focused on international subsidiaries not doing well for them, but our principal concern is now clearly domestic business. If you look at the numbers closely the standalone profit margins or earnings before interest, taxes, depreciation and amortization (EBITDA) margins have declined for nine quarters consecutively which is actually a bigger concern. The change in the business model whereby they are starting to take more project businesses, starting to make their business look more like ABB, Siemens in India where the power systems margins, EBIT margins have come down to as low as 7 percent for them. So, I would say that is a principal concern. We have further cut numbers by 14 percent for FY14 and now also cut marginal year target price to now Rs 83. Q: What are your EBITDA margin assumptions now for the full year for FY14? What does your full year EPS estimate stand at? A: For FY14, if you look at on a standalone business, we still expect the company to do margins of around 8 percent. We expect their subsidiaries margins to be as low as 1 percent. If you look at on an EPS basis consolidated EPS would be around Rs 1 in FY14. We do not expect that to be kind of a significant number, but we expect that to sharply turnaround in FY15 and that is why we have cut down our values in their domestic and overseas business actually separately. Q: What about Bharat Heavy Electricals (BHEL)? This quarter's numbers on the margin front did not look too bad, but do you have enough confidence to go out and buy it? A: If you look at BHEL's Q3, Q4 numbers or even going into FY14, profit and loss (P&L) does not make any sense. The company has an order backlog of around Rs 1.15 trillion, out of which around 10 percent could be slow moving. The question is how much BHEL wants to book out of that as revenues.
The companies can book revenues of Rs 50,000 crore or Rs 40,000 crore depending on what they want to execute, how much cash they want in terms of their working capital. The big problem is till the time order inflow remains significantly below their revenue run rate, we are actually staring at a bit margin cliff. Our sense is that the company's stable margins should be around 10-14 percent kind of band depending on what kind of revenue level we are looking at. So there is a very large downside to earnings which is just lurking out there. Whether it turns out to be Q2-Q3 or it turns out to be FY15 is anybody's guess. So BHEL has still a lot of pain left in the stock and we will stay away from that. _PAGEBREAK_ Q: What did you read into Larsen and Toubro (L&T) guidance and dialogue? Opinion is split between what they had to say about their order inflow versus how poor domestic business is. A: On the P&L side, order inflow was clearly the bright spot. If you look at numbers closely in FY13, their domestic business order inflows grew by 26 percent which is very heartening. The question mark is what happens to the revenue side. In the last 5-6 years we have seen enough cycles both with L&T, BHEL and some of the larger engineering, procurement and construction (EPC) companies that there could be a lag between revenue and order inflow and vice-versa. L&T is going through that phase where domestic order inflow is very strong, yet the revenue booking is not very strong. Margin was a matter of concern. At the end of Q3 they had guided for up to 100 basis points (bps) margin decline in the engineering and construction (E&C) business. They delivered 120 bps. Clearly that has magnified because we are looking only at Q4 numbers. From that perspective, L&T is a company which should continue to be looked at on a yearly basis. The balance sheet side was very heartening. The company's working capital actually improved significantly in Q4. It is clearly following a roadmap to doing their return on equity (ROE) and return on capital (ROC) up by around 300-400 bps for next few years. From that perspective there are enough positives to take care of the negatives on the margin side in case of L&T. Finally, you cannot ignore an E&C company which delivers very strong order inflow growth for a long period of time. Q: Your space is almost done reporting. By the end of it, would you say that for FY14 and FY15, you have had to cut most of your targets; either price or earnings per share (EPS) targets? A: Across the board, I would broadly agree with that. Clearly, there has been a disappointment either on margins or order inflows. So we had to take our numbers down slightly. You also need to look at capital goods with and its sub-segments. Power related segments are doing much worse compared to others. If you look at the auxiliary power, that kind of themes or pure broader diversified infrastructure, are doing at least better on the order inflow side or on the margin side. We need to be more stock specific in this space rather than just look at from a broad brush on that.