Though share prices of capital goods companies have moved higher, their fundamentals have yet to catch up. The difference in valuations and price reflects the expectation of improvement in earnings in the coming months.
For the quarter ending December 2012, analysts expect the sector to grow between seven and eight per cent on a year-on-year basis. This is an improvement over the 6.2 per cent growth recorded in the second quarter ending September 2012. Higher growth reflects improvement in execution of projects by the companies as well as, to some extent, clients releasing their dues, which has helped the companies in the sector to move on with their on-going projects.
However, growth is skewed towards larger players in the sector like L&T and BHEL and companies in the transmission and distribution space like ABB and Crompton Greaves. There are positive signs for investors from the sector in the form of order book to sales at about 2.3 times staying at the levels seen in the last quarter. More importantly, order intake has seen growth of about seven per cent in the December quarter unlike a 15 per cent decline in the September quarter.
“The sector has experienced severe turbulence led by policy logjam, tight credit conditions, lengthy land acquisition procedures and tough environmental clearance norms, which have reflected in thin order inflows and dwindling cash flows of companies, marring growth prospects. However, there are signs of improvement as delayed projects get awarded and reforms on land acquisition, environmental clearances and power are up for discussion,” says Amol Rao, who tracks the sector at Anand Rathi Shares and Stock Brokers, in a sector preview note.
Margins pressure
While growth might be visible the sector is expected to face margin pressure. On an average, the sector's margin is expected to be in the region of 12.3 per cent, which is about 80 basis points lower than in the corresponding quarter last year. This, despite the correction in the commodity prices, reflects the fact that many of the companies are not even able to recover the fixed costs on the expanded capacities as well as due to higher competition leading to price erosion.
| MARGINS UNDER PRESSURE | ||||||
| In Rs crore | Sales | % ch y-o-y | OPM | chg (bps) | Net profit | % ch y-o-y |
| BHEL | 11,746 | 9.3 | 18.4 | -102.3 | 1,434 | 0.1 |
| Thermax | 1,258 | -0.8 | 9.8 | -102.0 | 89 | -7.2 |
| BGR | 785 | -2.4 | 13.6 | -274.0 | 32 | -41.4 |
| Siemens | 2,524 | 5.7 | 5.5 | 35.7 | 82 | 15.6 |
| ABB | 235 | 7.4 | 6.2 | 167.0 | 76 | 18.1 |
| L&T | 16,343 | 16.8 | 10.5 | 33.7 | 1,108 | 15.1 |
| Crompton Greaves | 3,238 | 7.0 | 5.1 | -89.0 | 71 | -18.6 |
| Source: Analyst reports, bps: basis points | ||||||
Analysts, on an average, expect BGR Energy’s operating margin to drop 274 basis points due to higher fixed cost and margin pressure in the EPC segment. On the same reasoning, BHEL too, could see its margins falling significantly. Cost pressure is expected to remain for some time. Analysts are not expecting volumes to pick up, which would put pressure on operating margins.
Negative earnings growth
Given this scenario, despite revenue growth, pressure on margins will dent the profit growth of companies. Additionally, higher interest cost, depreciation and negative impact of currency will be seen on the sector’s profitability. No wonder, on an average, the profit growth of the companies is set to be negative.
The biggest impact will be seen in the case of companies like BGR Energy, Crompton Greaves and Thermax, which is largely to do with the lower operating margins.
