Strong Q4 show by ABB, Siemens are early signs of capex recovery

However, due to higher share of short-cycle orders, operating margins took a 100-200 basis point hit

Back in February when most capital goods companies showed improved capacity utilisation, it pointed to early signs of turnaround for the sector. Now that belief has gathered more strength, thanks to a strong March quarter performance from ABB India and Siemens India. Even as their net profit took a hit due to change in accounting norms, the key takeaway was the eye grabbing growth in order inflows. For ABB India, the 28 per cent year-on-year (y-o-y) growth in order inflow came from power transmission and distribution (T&D) segment, while pockets such as renewable energy and railways also supported it. A similar case entails for Siemens India. The spike in order inflow (up 61 per cent year-on-year) in March quarter derives additional strength from cement, steel and automotive (construction equipment) sectors as for modernisation, maintenance and expansion is underway in these industries.
 
This has prompted a few analysts to believe that these could be early signs of turnaround in capacity expansion (capex) by India Inc. Edelweiss in a note dated May 15 says that the recovery in capex is pretty broad. However, unlike previous cycle which was benefitted by power generation, roads, metals and other infrastructure projects, the current leg of capex recovery encompasses sectors such as railways, oil and gas, defence and power transmission and distribution (T&D).
 
For the railways sector, planned capex of nearly Rs 856,000 crore - almost twice the capex planned in 2000-2015 is extremely positive. At this pace, Edelweiss affirms that the rail investments will far outstrip those in National Highways over the next decade. Sectors such as defence and power T&D where the efforts are underway to plug the existing systemic gaps, strengthen capabilities and open the sector for healthier private participation also warrant for a similar improvement. For oil and gas sector, change in emission norms forcing the refineries to adopt the BS-VI standards ahead of its implementation in 2020 is a big capex kicker.
 
We favour industry leaders that are best placed to ride the ongoing PSU capex and emerge prime beneficiaries of private capex pick up, whenever it happens," Edelweiss adds. Analysts at SBI Cap Securities concur with Edelweiss.
 
They insist that unlike the earlier capex cycle, which saw high participation from the private sector, the role and dependence on government spending may be high in the current cycle. "Capex would largely be driven by the government in the medium-term. Emergence of private sector capex is still some time away due to high number of shelved projects, low capacity utilisation in key end-user sectors and leveraged balance sheet," says SBI Cap.
 
These point to a much needed pick up in the capital goods sector. However, investors have to prepare for some volatility in profitability. March quarter results of ABB and Siemens indicated that due to higher share of short-cycle orders (with execution tenure of 12 months or less) operating margins took a hit by 100-200 basis points. This compression is likely to stay given the changing dynamics of order inflows. Results from Cummins India (May 18) and L&T (May 29) should give more clarity on this front. For now, stocks such as ABB India, Cummins India, Bharat Forge, L&T, Bharat Electronics and Engineers India are preferred by analysts.