Capital Goods - Results Preview - Inflationary Pressure to Impact Margin

Strong Tender Pipeline, Higher Commodity Prices to Impact Order Finalization

Capital goods sector witnessed healthy tender pipeline in sectors like Infrastructure, Data centers, Railways, Metro, Civil, Water Treatment and International Power T&D, however higher commodity prices may result in some spillover in order finalization. Rising crude price to boost capex in oil exporting economies like the Middle East, while oil importing economies like India may have a negative impact of the higher oil price. The ongoing Russia-Ukraine crisis has further escalated the inflated commodity prices, which likely to impact margin and execution in the near term. Companies with higher fixed price contract exposure will likely to be most impacted. Companies with lower fixed price contracts and cost-plus model will have better ability to withstand the commodity inflation during 4QFY22.

Price Hikes to Continue

Revenue growth for product companies is largely led by price with rounds of price hikes in the last couple of quarters. We expect the price hike may continue in the near term to restore gross margin. The demand for consumer durables and electricals was impacted in Jan'22/Feb'22 due to the Omicron scare and continued price hikes. However, demand picked up in Mar'22, particularly in summer categories like room AC/cooler/fans. Companies continued to face challenges due to the steep rise in commodity prices, elevated logistic costs and shortage of semiconductors.

Healthy Order Inflow

In terms of key highlights during the quarter, L&T announced orders worth ~Rs350bn in 4QFY22, and the labor availability was stable during the quarter. A minor execution impact is expected due to supply chain bottleneck and delayed exports during 4QFY22. For KEC, we expect healthy execution in the domestic T&D, railway and civil segments, while SAE Tower's execution and profitability will be impacted due to the higher steel prices and legacy projects. The workforce crunch and an additional cost of time overruns would impact profitability. We expect SAE Tower to report an EBIT loss in 4QFY22 and break even in 1QFY23 onwards with the completion of legacy projects. KEC reported the highest order inflow of Rs172bn in FY22, up 45% YoY, mainly led by the civil segment.

We expect our capital goods coverage universe to report 6.3% YoY growth in revenue, while EBITDA and PAT to decline by 13.4% YoY and 11.8% YoY respectively in 4QFY22E. EBITDA margin is expected to decline by 60bps YoY to 11.4%.

Our View:

The Indian economy witnessed a sharp recovery in the past few quarters, while the strong capex revival in capital goods sector is likely to continue ahead. Key economic indicators like GDP, GST collections, manufacturing PMI, core sector output growth, import-export data among others continue to show that the ongoing economic recovery should propel a sustained improvement in corporate earnings. GST collections for Mar'22 hit a record high of Rs1,420bn, up 6.8% MoM. The 8 core sector industries notched up a positive growth rate. India is one of the resilient and fastest-growing economy during the pandemic in the world. The sustained increase in government capex could be supportive to the economy until private capex revives. To reduce India's dependence on foreign military equipments, the ministry of defence has identified various items for indigenization and 'Make-II' list, which will benefit the defence companies ahead. The ministry of defence announced a second negative import list of 108 items, which are likely to provide a boost to Atmanirbhar Bharat and indigenization plans in the defence sector, with the active participation of both public and private sectors.

Our Top Picks: L&T, Kalpataru Power and KEC International

Link to the report

Source : Equity Bulls

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CapitalGoods RelianceSecurities ResultsPreview Q4FY22