Here's What May Drive India's Multi-Year Capex Cycle
India’s private capex, a precursor to a prolonged spike in demand and economic growth, took a hiatus of about a decade. After a few false starts, analysts and companies say, it’s at the cusp of a multi-year surge.
There are enough signs already. Order flows of capital goods makers are growing, companies have started pledging investments to avail production-linked incentives. And there is a shift away from China. All happening at the same time.
Corporate capital expenditure usually starts after a couple of years of "very robust" profit growth, according to Nirav Sheth, chief executive officer, institutional equities at Emkay Global Financial Services Ltd. And the last 18 months, he said, have seen profits rise.
Capex spending dried up in India as the global economy recovered from the 2008-09 global crisis. To drive private investments, Prime Minister Narendra Modi’s government cut corporate taxes to among the lowest in Asia in 2019 as growth slowed. But then, the pandemic struck.
Meanwhile, the government spent on infrastructure in the last few years to shore up the economy that was slowing down even prior to the pandemic. The Covid-19-led disruption, however, exacerbated India’s fiscal problems, delaying targets to bring down the budget gap.
The push to develop roads to ports suggest it will continue, aided by higher tax revenue. And signs are encouraging even for private investments.
One factor aiding investment commitments are the incentives to boost local production of bulk drugs to semiconductors.
Chemical makers Neogen Chemicals Ltd. and Gujarat Fluorochemicals Ltd. have prepared capex plans for raw material that goes into making batteries for electric vehicles, according to Edelweiss Broking Ltd.
Automakers including Mahindra & Mahindra Ltd., Tata Motors Ltd., Hyundai Motor India Ltd. and Bajaj Auto Ltd. have lined up spending on manufacturing EVs.
Pharma, bulk drugs and medical equipment makers, too, have pledged investments to avail incentives.
In all, companies across 13 sectors have committed or made investments worth Rs 12,960 crore under the PLI scheme. And it’s led by makers of mobile phones and electronic components so far.
Sugar mills, too, are spending to boost ethanol capacity as India pushes for higher blending to divert surplus sugarcane and reduce the import bill on fossil fuels.
Equipment Orders Surge
One of the first segments to benefit from a capex cycle are makers of capital goods, or equipment used by other industries.
Tata Steel Ltd., according to DSP Mutual Fund, acknowledged in its conference call with investors and analysts that demand for steel will be driven not by the automotive segment, but by capital goods.
Order flows of India's six large capital goods companies—Siemens Ltd., ABB India Ltd., Honeywell Automation India Ltd., SKF India Ltd. and Schaeffler India Ltd.—have recovered.
According to estimates by Motilal Oswal Financial Services Ltd., barring a brief fall during the second Covid-19 wave, order inflows of heavy machinery suppliers in its coverage universe rose about 64% over a year earlier in the first half ended September.
ABB’s management, after the quarter ended September, indicated a revival in ordering activity across mining, cement, specialty chemicals, and oil and gas sectors. KEC International Ltd. said it had a “strong bid pipeline” across the international power transmission and distribution business.
SKF India has seen orders pick up from automotive and industrial segments in the past few months, according to Manish Bhatnagar, managing director of the company.
"We are looking at a big boom cycle starting now. We are seeing true capex investments not just being announced but being implemented," Bhatnagar said in an interview to BloombergQuint. "I am talking from the vantage point of being able to peep into our customers' sites and see what is happening there and not just reading in newspapers."
Annualised order inflows of the six large capital goods makers have grown over FY20, according to BloombergQuint’s estimates based on disclosures for the first half ended September. In the last capex cycle from FY04-08, the metric had grown at an annualised rate of 30%, going up to 50%.
Exports are a sizeable contributor to the sales of Indian Industrial companies, dominated by Honeywell, Siemens and Cummins India Ltd. Larsen & Toubro Ltd., Kalpataru Power Transmission Ltd. and KEC International Ltd., too, have a significant international exposure.
But utilisation levels are low. As export demand rises, these companies will be able to service clients without incurring capex. For multinational companies, spare capacities and support from European, and U.S. parents could drive benefits.
BofA Securities cited the example of Cummins India that has a utilisation rate of 50% as of September along with the lowest cost structure within the group globally.
Despite 80-85% capacity utilisation, ABB India, too, cited enough headroom to cater to the “interests of the group in using India as an export base” given ongoing expansion of certain plants and surplus land bank.
While the Omicron impact will be known only after the third-quarter results commentary, L&T had said after the second-quarter results that international prospects are looking robust across segments, including hydrocarbons, power transmission and distribution, oil and gas, and water thanks to higher oil prices.
The shift away from China to diversify supply chains is already playing out. India is expected to be a key beneficiary.
Most of the industrial MNCs in India are showing 30-40% growth in exports, Manish Gunwani, chief investment officer-equity at Nippon India Mutual Fund, told BloombergQuint in an interview. That, he said, is evidence of the fact that higher sourcing is happening from Indian shores.
The shift is not limited to the industrial segment.
Contract manufacturer Dixon Technologies Ltd. has inked a joint venture with Japan's Rexxam Co. for making air conditioner control boards.
The plan is that the Japanese company will shift some supply chains to India, and the joint venture will serve both the domestic and global markets, Saurabh Gupta, chief financial officer at at Dixon Technologies, said in an interview.
Two large global suppliers of raw materials to the fragrance industry have already invested in Indian peers to boost manufacturing presence in the country.
Individually small, but together these suggest companies are increasing their footprint in India.
Biden’s Infra Push
The Biden administration is pushing a $1 trillion infrastructure spending bill to shore up the American economy after the pandemic.
Analysts from brokerages including BofA and Prabhudas Lilladher say the spending on highways and bridges in the U.S. could provide opportunity for construction-linked capital goods suppliers like Cummins and engineering, procurement and construction firms such as L&T.
Besides, the $73-billion spending on modernising the electrical grid, part of Biden’s infrastructure bill, could be an opportunity for Indian transmission and distribution companies that have gained sufficient overseas experience as domestic growth slows.
India Inc. View
Corporate commentary is optimistic.
Macroeconomic parameters have begun favouring private capex although likely ordering is expected only in FY23, L&T said after the second-quarter earnings.
According to Cummins' management in the second-quarter earnings call, the Middle East has started recovering on account of oil prices and Asia-Pacific looks better relatively. Latin America and Europe are lagging but both geographies should recover in the next two quarters.
While ABB hasn’t mentioned any large greenfield capex yet, multiple asset upgrades have driven double-digit growth in order inflows across segments.
And past experiences show that when the capex cycle turns, it’s accompanied by growth in margins, core return on equity and earnings, while lowering working capital days. Together, these support valuations. And companies sense that will happen again.
"If I was a manufacturing guy, I would be very happy,” Bhatnagar of SKF India said. "This is going to be our decade.”