Mr. Parikshit D Kandpal, CFA, HDFC Securities and Mr. Manoj Rawat, Institutional Research Analyst, HDFC Securities
Q2FY22 broad-based recovery: Execution is expected to gather momentum with the ironing out of the supply chain issues, substantial improvement in labour availability, and timely customer collections. Competitive intensity during the H1FY22 ordering (NHAI~INR 360bn) has been high due to couple of candidates shoring up the order books ahead of their IPOs. Larger orders were missing and are likely to pick up during H2FY22. With central elections coming up in Q1FY25E, we expect strong ordering momentum to build up in H2FY22/23E. The government is gearing up to launch the first ever National Infrastructure Masterplan - Pradhan Mantri Gati Shakti (to be unveiled on 13 Oct 2021) - which envisages INR 100trn infrastructure investments. This shall be positive for Industrials and drive government / private Capex.
Tailwinds building up for tangible long term growth: The receding second wave of COVID-19 has initially aided opening up of the economy and recovery in tax revenue. Decision making on both government and private Capex may pick up as offices open and international travel resumes. The government has doled out PLI schemes and cut taxes to make local manufacturing attractive. Global supply chains are seeing disruptions both on changing energy dynamics from fossil fuels to green energy and political forces realignment. We believe India will see increased traction and benefit from further localisation by Industrial MNCs operating out of here. We have recently seen ABB's and Siemens' commentaries on firming up investment plans in India.
Capital goods growth to be driven in the near term by cyclical recovery and in longer term by higher exports: Whilst Q1FY22 ordering remains muted, there could be a spillover impact on Q3FY22 pick-up. In the interim, capacity expansion annoucements by Industrial product companies will be looked at. Exports may see pick-up as global economies continue to be resilient. This augurs well for L&T, Siemens, Cummins, KEC, Kalpataru and ABB. Recovery in auto, pharma, real estate, hospitality and F&B augurs well for automation companies.
Strong recovery before YoY/QoQ: We expect EPC/Infra universe (ex-GR Infra) revenue/EBITDA/PAT to grow 9/9.5/27% sequentially and 39/31/120% YoY with EBITDA margin to expand by 6/(98.2)bps QoQ/YoY. In capital goods, revenue/EBITDA/PAT are expected to grow 22/30/55.5% sequentially and 11.5/12.4/(184)% YoY with EBITDA margin expanding by 68/8.7bps QoQ/YoY. The valuation of EPC/infra universe is at ~13x FY23E core EPS and still away from long term mean of 19x.
Case building up for valuation multiple expansion: Tailwinds discussed above may have a landfall on earnings over longer term, while in the interim, we would build a case for multiple expansion. We have realigned our multiple higher for select cap goods/infra EPC to factor in the benefit arising out of (1) likely momentum on government Capex, (2) real estate recovery and its impact on private Capex revival, and (3) likely expansion of global capacities in India due to realignment of supply chains. We believe that the market may not be correctly pricing in the valuation multiple and any large scale Capex may lead to upside risks to our Industrial valuation multiples.
Recommendations and stock picks: From a near to mid-term perspective, the government would drive ordering, and private Capex/opex will be late-cycle recovery. Hence, recovery plays with high government exposure will remain in focus. In capital goods, LT and Cummins India are our top picks. In the mid-cap space, GRIL, KNR, PNC, NCC and Ashoka are our top picks.