Rally in capital goods stocks backed by fundamentals

Capital goods stocks are among the surprise outperformers so far in 2017. While the S&P BSE Sensex has returned over eight per cent gains since the start of the year, stocks such as ABB India, Siemens, Cummins India and BHEL have outperformed the index with returns of 9-29 per cent. GE T&D (formerly Alstom T&D) has gained by 3 per cent in this period. While the increasing preference to non-consumer oriented stocks has helped them perform better, the improving fundamentals as reflected in their recent quarterly earnings (except ABB, which is due on Thursday) indicates that the good ride may continue. There are four critical operational metrics that look more positive today, than what was a year ago.

Improving execution: Recovering from a pale 2016 performance, capital goods companies are seeing on ground progress with their projects. Project execution, which was stretched and unpredictable a year-ago, is gathering momentum. Which is why in the December quarter most companies (except GE T&D) have witnessed 16-19 per cent growth in their revenues; Siemens' revenue is up 62.8 per cent, on a year-on-year basis. With most ongoing projects being government-backed orders, companies are positive that the execution will only get better in the coming months, given the thrust on infrastructure spends.

Better operating levers: As execution improved, ability of companies to juice out more from existing capacities has also increased. This is reflected in the operating profit margins, with GE T&D putting its plant to maximum use in Q3. Efficiencies setting in helped Siemens and BHEL become profitable at operational level. As plant utilisation improves further, the hope is that margins should brighten. However, in the context of the current pricing pressure (bulk of orders come from government tenders wherein bids tend to be competitive), unless the private participation kicks in, operating margins may stay remain well below the 2013-14 levels of over 15 per cent. That said, a noteworthy shift in favour of high-technology products such as over 756 kilowatt engines and increased shift towards high voltage direct current projects would be a boon for the power equipment players.

Order inflows: The government's ability to award orders in also improving. This has helped GE T&D increase its order book by 38 per cent in December quarter while Siemens saw a five per cent growth in its order inflows during this period. The pipeline also looks promising. While BHEL disappointed expectations on this front with orders flows of only Rs 1,700 crore in Q3, it is hopeful that in March quarter it could procure at Rs 15,000 crore of order wins. Nonetheless, Sunil Mathur, MD & CEO, Siemens points out that he awaits large public tenders in the railways and energy transmission segments. In 2017-18, companies are confident that the government's rural electrification plans should also boost their order books.

Diversification: Having expanded the product offering to suit all ends of the spectrum is working to the advantage of most capital goods companies. In case of Cummins and Siemens, this has helped them tap opportunities in the railways sector where the thrust has shifted to upgrading the engine capacities from the earlier focus of adding bogies. ABB is also benefiting by supplying transformers to Indian Railways. While BHEL hasn't seen much progress with Indian Railways contracts off late, the company has proven track record whether for locomotives, engines or electrification.


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