Stocks are being valued at lower multiples with the Street factoring in project delays.
With few takers for cars and even fewer buyers for commercial vehicles, it seemed that auto stocks would be the worst hit in 2008. But surprisingly, the BSE Capital Goods index has underperformed the BSE Auto index so far this year, losing 66 per cent compared with a fall of 59 per cent for the auto index.
For most of the year the capital goods space did fairly well because it appeared that companies wouldn’t pare capital expenditure, even if the economy slowed down somewhat. Quarterly numbers for both the June and September quarters were reasonably good though there were some signs that growth was slowing down. For instance, ABB’s sales were up just 15 per cent in the June quarter and 10 per cent in the September quarter.
Nevertheless, the order books looked robust. Both Larsen &Toubro and BHEL saw orders increase by around 45 per cent y-o-y in the September quarter. But with industrial growth slowing down, the outlook hasn’t been as promising and in the last three months the Cap Goods index has plummeted by 36 per cent with October being the worst month for the sector.
With steel companies scaling back production, it was becoming clear that demand, for a host of products, was flagging. As a result, analysts have trimmed earnings numbers, pencilling in lower revenues since they believe that execution of projects could slow down. The delay in execution is more the result of customers not having adequate resources to go ahead with projects, in a tight money market environment, rather than any fault of the equipment makers.
But nonetheless, delays could be a reality even if the orders are from government-owned companies. Moreover, although costs have abated somewhat, not all players have been able to pass on the increases to customers.
The net result is that earnings would be lower than what was expected six to eight months back. That’s now reflecting in the valuations. For instance, L&T (consolidated) which was trading at a price-earnings (P/E) multiple of around 30 times its estimated 2008-09 earnings in March, now trades at just under 17 times. The de-rating hasn’t been quite so sharp for BHEL; from a P/E multiple of around 22-23 times in March, it now trades at around 20 times estimated 2008-09 earnings.
Stocks such as ABB have lost 70 per cent since the start of the year and are now trading at 13 times estimated earnings. Although interest rates are coming off, it could take a while before companies decide to go ahead with projects that they had held back because the economy continues to slow down. So capital good stcks too could take time to recover.
