Capital Goods - Results Preview - Strong Quarter; Healthy Revenues on Better Pricing and Volumes

Mr. Arafat Saiyed - Senior Research Analyst at Reliance Securities.

Capital goods sector witnessed healthy tender pipeline with government's thrust on infrastructure development which has augured well for the sector. Private capex started improving with continued demand for new edge sectors such as digitalization, data center, metro, EV, etc. which is likely to support ordering activity in the coming quarter. Although enquiry level has improved over past few quarters, pace of conversion of enquiry into order inflow and execution are key monitorable due to higher commodity prices and supply chain disruptions. The management guidance on execution pace, margin recovery, WC management and update on supply chain will be the key factors to be monitored going ahead. 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 will 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 1QFY23.

Another round of price hike amid inflationary pressures

For Consumer durable companies, the revenue growth was largely led by pricing with rounds of price hikes in the last couple of quarters. We expect that the price hike may continue in the near term to restore gross margin. The demand for consumer durables and electricals were strong in Apr'22 but has seen softening since May22. Consumer Durables witnessed strong volume and pricing growth after two consecutive seasons of wash-out due to lock down and supply chain disruptions. However, the companies continued to face challenges due to the steep rise in commodity prices, elevated logistic costs and shortage of semiconductors. Cables and wires companies witnessed price cuts of 5-7% in 1QFY23 due to correction in commodity prices. The channel is going through lower inventory due to volatility in the copper prices.

Healthy Order Inflow to Continue

In terms of key highlights during the quarter, L&T announced orders worth ~Rs250bn in 1QFY23, and the labor availability was stable during the quarter. A minor execution impact is expected due to supply chain bottlenecks and delayed exports during 1QFY23. 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 also impact profitability. We expect SAE Tower to report an EBIT loss in 1QFY23 and break-even 2HFY23 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 21.4% YoY growth in revenue, while EBITDA and PAT are expected to increase by 21.3% YoY and 31.4% YoY respectively in 1QFY23E. EBITDA margin is expected to remain flat YoY at ~10%.

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 growth, 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 June'22 hit a record high of Rs1,446bn, up 56% YoY. The 8 core sector industries, notched up a positive growth rate. India was 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 going ahead. Recently, the Defence Acquisition Council has approved capital acquisition of Rs764bn for the Armed Forces to strengthen indigenous defense capabilities and reduce foreign spending on systems and equipment. These funds would be used to procure major platforms, including next-generation Corvettes for the Navy (~Rs360bn), aero-engines for Dornier aircraft & Su-30 Mk-I for the Airforce and tanks, radar & vehicles for the Army.

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

Source : Equity Bulls

Keywords

CapitalGoods Q1FY23 ResultsPreview RelianceSecurities