Capital Goods index records historic outperformance. Will the dream run continue?

Cap Goods

The BSE Capital Goods index climbed unprecedented heights, outstripping the Sensex by a significant margin, in FY24. With an impressive 80 percent surge over the past year, the index has eclipsed the benchmark's 25 percent gain, marking the highest level of outperformance in 18 years.

Keeping up a trend, the capital goods index recorded the longest streak of outperformance in FY24, when it raced ahead of the Sensex for the fourth consecutive year.

Yet, in terms of actual rate of outperformance, last fiscal ranks second only to FY06, when the BSE Capital Goods index delivered an outperformance of 82 percent, clocking an annual return of 156 percent, higher than 74 percent for the BSE bellwether.

On April 2, the Capital Goods index hit a new all-time high of 62,370, with a gain of 0.65 percent. Heavyweight stocks like L&T played a pivotal role in driving this surge. Other prominent players in the league included BEL, Laxmi Machine Works, Carborandum Universal, Hindustan Aeronautics, Thermax, ABB India, and Siemens India. All of these scaled their fresh life highs on the day.

Also read: Debt-free capital goods MNCs outperform Nifty on capex boosters

Analysts attribute this remarkable performance to a confluence of factors. “The capital goods sector is firing on all cylinders,” Purvesh Shelatkar, head of institutional broking at Monarch Networth Capital, said. "While government support, coupled with a resurgence in private capital expenditure, has laid a strong foundation for growth, improvements in capacity utilisation among manufacturing companies, and margin expansions across the capital goods segment, have propelled the profitability."

This dynamics is evident in the numbers. Earnings growth of the capital goods sector has outpaced that of the broader market. BSE-listed capital goods companies recorded a staggering 38 percent growth in earnings, far surpassing the 18 percent growth by Sensex companies in the past fiscal. Expectations of continued surge in earnings has led to a notable expansion in the price-to-earnings (PE) ratio of the BSE Capital Goods index, reflecting a rerating of stocks driven by solid fundamentals. The index is trading at a trailing P/E of 41x compared with Sensex’s 24x.

While healthy order books provide revenue visibility, enhanced supply chain efficiencies and robust balance sheets further bolster the sector's resilience, analysts said. However, there is a chance that stock prices may take a breather. “There could be some consolidation in stock prices in the first half of FY25 because of general elections. Otherwise, the demand side scenario remains robust and we should see the trend continuing,” Hemil Shah, Fund Manager, Torus ORO PMS, said.

Shah believes capex will be good in coming year keeping stock on high growth trajectory.

This view is echoed by other analysts who believe despite steep valuations, stocks may have more steam left in the medium-term. Avinash Kumar of LKP Securities highlighted the sector's immense growth potential, driven by a sizable total addressable market (TAM) and the prospect of improved export markets as factors that support high valuations beyond the near-terms earnings numbers. Foreign Institutional Investors (FIIs) have also shown confidence in industrials, adding buoyancy to stocks, he said.

Shelatkar is particularly bullish on debt-free MNC capital goods companies like ABB, Siemens and Cummins which should ride the cyclical upturn and seem poised to deliver higher double digit, superior to that of Nifty companies.