Under-Owned And Unfavoured, Are Capital Goods Stocks Bottoming Out?
There are some sectors that have been a no-go for investors over the past few years. While infrastructure companies in the build-own-operate-transfer space and select real estate companies would top the list, capital goods stocks aren’t far behind. Stocks like Thermax Ltd. (peak price of Rs 1,297 a share on March 10, 2015) and Bharat Heavy Electricals Ltd. (peak price of Rs 297 a share on February 3, 2015) have been big laggards. And not without reason. Thermax’s revenue has fallen from Rs 5,395 crore in March 2015 to Rs 4,483 crore by March 2017. BHEL has not set the stage on fire either, with the last quarter’s results showing revenue remaining flat and negative EBITDA. The scenario for TD Power Systems Ltd., ABB India Ltd., or Siemens Ltd. has not been too rosy either. However, the trick in investing is always about catching the cycle at its bottom. The question then is: is this the bottom of the cycle for capital good companies?
Sectors which have been dormant for the last few years have started showing signs of expansion and activity, resulting in order inflows for some capital good companies.
A lot of orders are coming from outside India, which makes some capital goods companies less dependant on the Indian government orders coming through.
Private companies have started announcing capital expenditure plans.
- Ramco Cements Ltd. recently announced a Rs 1,000 crore expansion plan.
- Fertiliser companies have announced expansion plans after almost 6-7 years.
- Oil and gas companies have announced refinery upgrades, and have already placed orders with capital goods companies, with strong signs of more orders in the pipeline.
If this trend broadens, it will come as a big relief for a sector that has been reeling with cash flow issues and order inflow reduction. Thermax is dealing with the sales degrowth by reducing costs and improving its product mix. This has resulted in a margin improvement - from 10.71 percent in 2014-15 (FY15) to 11.49 percent in FY17. Thermax’s free cash flow has been positive in the last three years, despite the challenges. Remember, during the previous capex cycle, from FY06 to FY08, the growth in profit after tax for companies like Thermax was over 50 percent. Not all companies have been able to undertake the exercise that Thermax has. But the fact that after a long break, the otherwise dormant sector has started showing activity, and that international order flows are also making their way to Indian companies, is the boost that this sector needed.
What also makes this pocket of the market interesting is that it is under-owned. Institutional investors (foreign and domestic) have not put in fresh money into the sector.
The Thermax management believes that this may be the phase where the capital goods industry is bottoming out.
MS Unnikrishnan, the managing director and chief executive officer, told BloombergQuint that while the sector won’t see improvement across the board, the picture is improving for construction equipment and textile machinery.
Thermax believes that the industry could grow at about 7-8 percent in FY18, and if global demand is supportive, double digit growth may be possible in FY19. As is the nature of the game, large institutional ownership will follow performance. The question to ask yourself is, has the game truly begun?
Niraj Shah is Markets Editor at BloombergQuint.