Industrials - 1QFY22 Results Preview Report - Loss in momentum due to second wave - HDFC Securities

Mr. Parikshit D Kandpal, CFA, HDFC Securities and Mr. Chintan Parikh, Institutional Research Analyst, HDFC Securities.

- Q1FY22 marred by multiple challenges: When the sector was closing in on normalisation, the resurgence of COVID-19 led to a loss of momentum. Labour migration picked up in early part of Q1FY22; although with cases trending down, labour availability has normalised now. Most of the coverage universe lost precious early part of Q1FY22, resulting in execution coming down to 60-100% of Q4FY21 exit. However, YoY growth is robust on a low base of Q1FY21. Ordering too got impacted as government offices saw thin attendance, impacting key decisions. Going into Q2, the bidding has resumed and some ordering has already taken place. We expect the bid momentum to pick up from here on. With central elections coming up in Q1FY25E, we expect strong ordering in FY22/23E.

- COVID-19 second wave impacts execution; competitive intensity to reduce: The second wave of COVID-19 created a panic in the early part of the first quarter. The impact, though, was muted vs. last year, manifested in the mass exodus of migrant labour. Our channel checks suggest that sites are now reaching labour normalcy and, with reduction in COVID cases. Further, the competitive intensity is expected to reduce despite a large part of awards in FY21 going to unlisted players. This time, these players have a limited appetite to bid for HAM projects.

- Capital goods growth was impacted to a lesser extent as supply chains remained intact and underlying demand saw less damage (YoY): Whilst the ordering saw slackness in Q1FY22, there could be spillover impact from strong ordering in Q4FY21. Exports may see some 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, and F&B augurs well for automation companies.

- COVID impact to result in muted Q1FY22 performance vs. Q4FY21 as Q1FY21 low base not a correct comparison: We expect most of the coverage universe to report a strong YoY growth in revenue/PAT. NWC and debt are expected to remain stable. On a QoQ basis, we expect sequential revenue/EBITDA/PAT de-growth of 21.2/22.3/33% for our infrastructure coverage.

- Commodities price impact to be more pronounced for short cycle order companies: We expect short cycle order companies to see more pronounced impact on margin. Price hikes have been taken by Cummins (by 5%) and other MNCs earlier. For EPC companies, accrual accounting and inflation cushion in HAM projects may result in limited margin cuts. For our infrastructure/cap goods coverage universe, we expect EBITDA margin contraction of 23.2/194bps QoQ. KEC is the worst impacted by commodity inflation.

- Outlook for FY22E: With the recent rally in the Infrastructure/Industrials stocks the valuation has moved closer to ~9x FY23E core EPS and still away from long term mean of 15x. We believe that strong balance sheet/cash flows generating companies will continue to further re-rate. Weak balance sheet companies will catch up but valuation gap may not converge.

- 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, KNR, PNC, NCC and Ashoka Buildcon are our top picks.

Source : Equity Bulls

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