23 February 2015 | Vol – 3 / 2015
CAPITAL GOODS INSIGHTS
The Butterfly Effect
(Vol III)
Investment cycle gradually gaining momentum; Exports hamstrung by weak global demand
n
n
n
n
Improvement in business confidence is visible with projects added at INR2.3t (3mma, Jan 2015), up 120%
YoY. Still, this is yet to be reflected in on-ground actions with actual tenders invited (for project awards) at
just INR1t (3mma, Jan 2015), down 40% YoY.
India’s Capex-J curve would be kick-started by accelerated public spending. Current trends suggest that
increase in projects under implementation in government sector has been steady at INR4.6t (12mma); while
for private sector is a negative number (indicating that projects completed are higher than projects added).
Since Sep 2014, growth rates in Indian Machinery exports have decelerated meaningfully to just 2.6%
(3mma, Dec 2014) v/s 13.6% (12mma, Dec 2014). Another important monitorable is the increased
competitiveness of European players in the traditional markets, given the sharp EUR depreciation.
Key trends to focus: Beneficiary of kick-starting stuck projects/Companies positioned in mid-value products.
BHEL, VOLT, CRG are top picks. Despite near-term headwinds, prefer L&T from medium term perspective.
2007, and revenues of global industrial players
suggests that the sluggishness has continued for ~8
quarters now.
An important monitorable for Indian capital goods
exporters is the sharp depreciation of EUR that has
improved the competitiveness of European players in
the traditional markets of SE Asia and Africa. The real
appreciation (REER) of INR may also have had some
effect on slowing exports.
Investment cycle gradually gaining momentum
n
Economic activity has gathered some pace, and the
improvement in business confidence has created
congenial conditions for restarting the investment
n
cycle. Policy initiatives in land acquisition as well as
efforts underway to i) unlock mining, ii) increased FDI
limits, iii) expediting approvals and iv) supportive
monetary conditions should create a conducive
setting for industrial revival in the medium term.
n
We believe that the initial round of investment cycle
revival will be triggered by i) sustained recovery in
Sector strategy: BHEL, VOLT, CRG are top picks
consumption demand leading to increased capacity
n
Slowdown in consumption is a worrying signal and
improvement in sentiments is yet to reflect in on-
utilization and ii) investment push by public sector
ground actions. Thus, revenue growth for capital
leading to a virtuous cycle of cash flow generation in
goods players may possibly remain weak for few
the system. Simultaneously, sustained progress in
more quarters. While we do not dispute the
putting stalled projects back to work is important to
possibility of a recovery in the investment climate in
crowd-in new investments and also provide a much
the medium term, FY16/FY17 earnings are prone to
needed stimulus to aggregate demand.
downgrades. Valuations are demanding.
Exports hamstrung by weak global demand
n
We believe that the initial round of project awards
n
Since Sep 2014, growth rates in Indian Machinery
may well be a winner's curse. This is because PSU
exports have decelerated meaningfully to just 2.6%
capex is characterized by tender based bidding,
(3mma, Dec 2014) v/s 13.6% (12mma, Dec 2014).
elongated working capital cycles and continued
Export performance has been hamstrung by a
execution delays. In this environment, we identify
multitude of factors, including: i) weak global
key early cycle themes: (i) mid-value product
demand, ii) geopolitical tensions and iii) sharp
companies are better positioned given exposure to
currency volatility in several markets. Decline in
base industries and also large replacement demand,
crude prices by ~USD50/bbl has impacted global
plus better control on margins
(ABB, KKC, TMX, CRG)
trade by ~USD2t, leading to a sharp decline in
(ii) beneficiaries of improved execution in stuck
investment demand. Project awards in the Middle
projects
(L&T, BHEL).
East are near the lowest level of the range since
Satyam Agarwal
(AgarwalS@MotilalOswal.com); +91 22 3982 5410
Amit Shah
(Amit.Shah@MotilalOswal.com) ; +91 22 3029 5126
Investors are advised to refer through disclosures made at the end of the Research Report.
Motilal Oswal research is available on
www.motilaloswal.com/Institutional-Equities,
Bloomberg, Thomson Reuters, Factset and S&P Capital.

| CAPITAL GOODS INSIGHTS
Charts in focus
Improvement in sentiments yet to be translated in on-ground actions
Exhibit 1: Projects add up meaningfully at INR2.3t, +120%
YoY (3mma, INR B)…
3,500
3,000
2,500
2,000
1,500
1,000
500
0
Projects Added
% YoY
300%
200%
100%
0%
-100%
-200%
Exhibit 2: …but, tenders invited at just INR1t, down 40% YoY
(3mma, INR B)
2,500
2,000
1,500
1,000
500
0
Tenders
% YoY
200%
150%
100%
50%
0%
-50%
Source: Projects Today
Source: Projects Today
India’s Capex J-Curve to be kick-started by accelerated public spending
Exhibit 3: Gross Projects added – Increased share of
Government sector (12mma, % composition)
100%
80%
60%
40%
20%
0%
Pvt TTM %
Govt TTM %
Exhibit 4: Even in recent times, net projects under
implementation by Government is stable (12mma, INR B)
15,000
10,000
5,000
-
(5,000)
Incremental Govt ttm, INR B
Incremental Pvt ttm, INR B
Source: CMIE
Source: CMIE
Engineering Exports growth has decelerated post Sep 2014
Exhibit 5: Machinery export growth has decelerated sharply
to just 2.6% in Dec 2014 (3mma, % YoY)…
70%
50%
30%
10%
-10%
-30%
Exports
Imports
Exhibit 6: …On a 12mma basis, Machinery exports growth
stood at 13.6% in Dec 2014 (12mma,% YoY)
50%
30%
10%
-10%
-30%
Exports
Imports
Source: CMIE
23 February 2015
Source: CMIE
2

| CAPITAL GOODS INSIGHTS
I
nvestment cycle: gradually gaining momentum
Demand recovery continues to be a mixed signal
Economic activity has gathered some pace, and the improvement in business
confidence has created congenial conditions for restarting the investment cycle.
Policy initiatives in land acquisition as well as efforts underway to i) unlock mining
activity, ii) widen the space for foreign direct investment in defence, insurance and
railways, iii) expediting project approvals and iv) supportive monetary conditions
should create a more conducive setting for industrial revival in the medium term.
The improvement in business confidence is clearly visible, but yet to be translated
into actions on the ground. Continued contraction in consumption demand
remains a worrying signal. We believe that the initial round of investment cycle
revival will be triggered by i) sustained recovery in consumption demand leading
to increased capacity utilization and ii) investment push by the public sector
leading to a virtuous cycle of cash flow generation in the system. Simultaneously,
sustained progress in putting stalled projects back to work is important to crowd-
in new investments and also provide a much needed stimulus to aggregate
demand. We expect that the initial round of demand improvement will be catered
to by fast tracking stuck projects (during FY16), followed by announcements of
greenfield capacities (in FY17).
#1
Improvement in sentiments yet to be translated in on-ground actions
Economic activity has gathered some pace, and the improvement in business
confidence has created congenial conditions for restarting the investment cycle.
Policy initiatives in land acquisition as well as efforts underway to i) unlock mining
activity, ii) widen the space for foreign direct investment in defence, insurance and
railways, iii) expediting project approvals and iv) supportive monetary conditions
should create a more conducive setting for industrial revival in the medium term.
The improvement in business confidence is visible with projects added at INR2.3t
(3mma, Jan 2015) up 120% YoY. Still, the challenges in surmounting the gridlock
have proved to be formidable and is reflected in actual tenders invited (for project
awards) at just INR1t (3mma, Jan 2015), down 40% YoY. Continued contraction in
consumption demand remains a worrying signal.
Exhibit 7: Projects add up meaningfully at INR2.3t, +120%
YoY (3mma, INR B)…
3,500
3,000
2,500
2,000
1,500
1,000
500
0
Projects Added
% YoY
300%
200%
100%
0%
-100%
-200%
Exhibit 8: …but, tenders invited at just INR1t, down 40% YoY
(3mma, INR B)
2,500
2,000
1,500
1,000
500
0
Tenders
% YoY
200%
150%
100%
50%
0%
-50%
Source: Projects Today
Source: Projects Today
23 February 2015
3

| CAPITAL GOODS INSIGHTS
#2
We expect that the initial
round of demand
improvement will be
catered to by fast tracking
these stuck projects (during
FY16), followed by
announcements of
Greenfield capacities (in
FY17)
Investment cycle recovery to be a gradual process
While the initial phase of domestic investment cycle slowdown was impacted by
policy logjams, there is a sense of guarded optimism now on the near term outlook.
Manufacturing IIP remains sluggish and is down 0.8% in 3QFY15 (3mma), while
capacity utilization (as monitored by RBI) has declined to 71% in 2QFY15 (from peak
levels of 79% in 2QFY10). Increased consumption demand and lower interest rates
would be important triggers for simulating the investment cycle. Projects completed
(as a % of projects under implementation) have remained at abysmally low levels of
4.4%.
We believe that the initial round of investment cycle revival would be triggered by i)
sustained recovery in consumption demand leading to increased capacity utilization
and ii) investment push by the public sector leading to a virtuous cycle of cash flow
generation in the system. Simultaneously, sustained progress in putting stalled
projects back to work is important to crowd-in new investments and also provide a
much needed stimulus to aggregate demand. We expect that the initial round of
demand improvement will be catered to by fast tracking these stuck projects (during
FY16), followed by announcements of greenfield capacities (in FY17).
Exhibit 9: Manufacturing IIP remains at baseline levels (%
YoY, 3mma)
25
20
15
10
5
0
-5
-10
Manufacturing IIP % YoY 3mma
Exhibit 10: Projects completed (as % of projects under
implemented) remains at low levels (ttm)
12.5%
10.5%
8.5%
6.5%
4.5%
Projects completed had consistently
remained at 7%+ of projects under
2.5%
implementation
Projects Completed ttm, as % of Prj under Impl
Execution impacted
given
regulatory, financing
and viability constraints
Source: CMIE
Source: MOSL, CMIE
Exhibit 11: Investment cycle will take at least a year to turn around
Management Comments
If you were to be honest, nothing is going to change in ordering related to capital goods for a year atleast and you
M S Unnikrishnan,
would see a spurt of that happening in selected sectors maybe in the next year i.e. FY17 not FY16. That is a realistic
Thermax
outlook.
Investments will follow a sequence and will take time. For this year, we are projecting a GDP growth of 5.2-5.5%. That
growth was based on clearing stuck projects and faster decision making. As more and more efforts come, we can grow
Aditya Puri, HDFC Bank
at 6% next year. The delta of the investment will take it to 7%. But private investment will probably follow public
sector investment. Investment on ground takes time, may be another 18 months or so, from December.
It is still too early...But the fact is every other week, there are some policy decisions being taken in the right direction
and they are all pending implementation for many years and at-least they are getting cleared one by one. The hard
A M Naik, Larsen and
core capital intensive sectors like infra, power, heavy industries are yet to see a pickup in demand. But that's not due
Toubro
to the demand situation alone .These sectors need billions and billions of dollars and the question we need to ask
ourselves is where is the money coming from with all the constraints in various segments?
Y M Deosthalee, CMD, It is a bit premature to talk about a turnaround, given the complexity of issues. But there is an under-current of
L&T Finance
sincerity and urgency from the new government, to signal and demonstrate change through concrete action.
Source: MOSL, Company
Company
23 February 2015
4

| CAPITAL GOODS INSIGHTS
#3
Please refer our detailed
sector report on “India’s
Capex J-Curve” in April 2013
India's capex J-curve to be kickstarted by accelerated public spending
Post 2012, India's investment cycle has collapsed. In our opinion, India's capex J-
Curve would be kick-started by (1) reorientation of fiscal expenditure which could
accelerate spending on flagship government projects, and (2) government's attempt
to address the contentious issues in several sectors, leading to increased capex by
Central and State Public Sector Units. This phase will then be followed with revival in
the industrial cycle culminating with traction in greenfield and mega projects.
Historical analysis suggests that government spending towards project
investments has been consistent, while private spend has been more volatile:
n
During
1998-2004,
when the investment climate had collapsed, incremental
projects under implementation by the government sector averaged at INR443b
per annum v/s negative INR110b per annum by the private sector (negative
number indicates that project completions were higher than projects added,
and thus denote a decline in projects under implementation).
n
During the
2004-2011
boom period, incremental projects under implementation
by the private sector at INR5.5t per annum were ~2x of the government sector
at INR2.9t. Thus, private capex bounced back sharply in a recovery.
n
Current trends suggest that history is repeating itself, with increase in the
private sector projects under implementation remaining at a negative number
since Dec 2012; while for the government sector, it has been steady at INR4.6t
(ttm).
Exhibit 12: Incremental projects under implementation by
Government sector stable across cycles (12mma, INR B)
Incremental Govt ttm, INR B
15,000
10,000
5,000
-
(5,000)
Incremental Pvt ttm, INR B
Exhibit 13: Even in recent times, net projects under
implementation by Government is stable (12mma, INR B)
15,000
10,000
5,000
-
(5,000)
Incremental Govt ttm, INR B
Incremental Pvt ttm, INR B
Source: CMIE
Source: CMIE
Exhibit 14: Gross Projects Added: Increased share of Government Sector (% composition)
100%
80%
60%
40%
20%
0%
Pvt TTM %
Govt TTM %
Source: CMIE
23 February 2015
5

| CAPITAL GOODS INSIGHTS
23 February 2015
6

| CAPITAL GOODS INSIGHTS
#4
We expect few of the initial
projects in consumption led
industries to possibly kick-
start in next 9-12 months;
and then followed by
investments in core
industries in ~12-18 months
Sense of Guarded optimism on near term outlook
n
n
n
Banking credit disbursement growth (net of repayments) to the industry
(excluding infrastructure and construction) stood at just 4% on 12mma basis till
Dec 14; and is at the lowest levels since 2007. The data suggests limited traction
in project execution, given that a large part of the incremental growth is being
led by working capital requirements. Incremental bank credit towards industries
remains an important monitorable to access the momentum in terms of
investment cycle.
We expect the initial momentum in investment cycle to be led by new capacity
announcements in consumption led industries (like FMCG, Pharma,
Automobiles, Chemicals, etc), and then percolating down to core industries (like
cement, steel, hydrocarbons and fertilizers). We expect few of the initial
projects in consumption led industries to possibly kick-start in next 9-12 months;
and then followed by investments in core industries in ~12-18 months.
The key risk is continued slowdown and delayed uptick in consumer spending.
During 3QFY15, several categories including Passenger Cars and FMCG products
witnessed a slowdown in demand which was a worrying signal.
Exhibit 16: Outstanding credit to industry (excl infra /
constr) is up just 4% YoY, lowest levels since 2007 (12mma)
20,000
15,000
10,000
5,000
-
O/s Credit to Industry, ex Infra / Constr (INR b)
40.0
% YoY
Exhibit 15: Net incremental bank credit growth to Industry
and Infra sector remains muted (ttm, INR B)
3,200
2,400
1,600
800
0
Infrastructure (Bank Credit, ttm, INR b)
Industries excl infra (Bank Credit, ttm INR b)
30.0
20.0
10.0
0.0
Source: RBI
Source: RBI
23 February 2015
7

| CAPITAL GOODS INSIGHTS
Exhibit 17: Industrial products – Capex environment remains constrained, with buoyancy in sentiments yet to translate into
investment decisions
Company
Kirloskar Oil Engines
Blue Star
Alstom T&D
Apar Industries
Thermax
Cummins India
Management Comments
There has been buoyancy in overall sentiments, still yet to see this translating into the market in a big way. However
we remain hopeful.
The market continued to be sluggish. While the macroeconomic indicators are positive and the economic
environment is conducive for growth, the revival of the commercial construction cycle is likely to take a few more
quarters.
Though there is positive sentiment in the industry, market continues to be challenging.
The demand in the power sector remained reasonably sluggish through this period. It is quite clear to us that the
CapEx cycle this time has to be fundamentally led by the government spending.
The drop in order booking is attributable to the domestic segment where enquiry inflow and finalization remained
subdued. We are still waiting for the real turnaround to happen at the ground level in the industry.
It's a very tough environment right now in general for capital goods in the country. So while financial sentiments in
the financial markets are very positive, with the expectation that reforms will come and there will be stimulus, et
cetera, we have not seen that yet in real demand in our industry.
Indian economy continues to be sluggish. There’s a lot of positive sentiment, lot of talk, but its not much of action
happening at large project level. Lot of activity is happening, but activity is not getting converted. Lot more inquiries,
lot more revival of old projects in the power sector, in the steel sector, but really in terms of orders and revenues, we
still have to wait and see what happens. But that’s on the large project side. On the normal industrial, we are
beginning to see a marginal improvement in the product segments that serve the normal industrial – the non-project
type of industrial demand. I am not elated about the increase, but definitely there is a consistent trend that we are
seeing and we are hoping this trend will pick up and become stronger.
There is a time lag between policy decision and ground level implementations. Expect gradual and steady
improvement. Lot of the action on the ground depends on fiscal prudence.
Market situation continues to be depressed. People talk of newer projects, most of the customers not willing to
commit to projects. Don’t really see any action on the ground.
Actually the number of the orders that we are actually seeing as being available in the environment has not really
taken off.
Source: MOSL, Company
Elgi Equipments
Larsen and Toubro
ABB India
Voltas
Exhibit 18: Volume growth across consumption categories has been impacted (% YoY)
Quarter Ending
Asian Paints
Colgate (Toothpaste)
Dabur
Godrej Cons (Soaps)
GSK Consumer
Hindustan Unilever
ITC (Cigarette)
Marico
- Parachute
- Hair Oil
- Saffola
Radico Khaitan
Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec 14
15.0
12.0
18.0
-2.0
5.0
13.0
2.0
10.0 12.0
7.0
12.0
11.0
10.0
4.0
15.0
15.0
14.0
13.0
11.0
8.0
11.0
11.0
9.0
11.0
7.0
5.0
7.0
5.0
10.0
10.8
12.4
11.6
9.0
9.5
12.3
9.0 10.7
9.0
9.2
8.3
8.7
7.4
19.0
20.0
17.0
24.0
6.0
2.0
4.0
7.0
4.0
6.0
-4.0
0.0
2.0
LSD
8.0
12.0
7.0
7.4
4.5
6.0
8.0
7.0 10.0
11.0
8.0
3.0
2.0
5.0
9.8
9.1
10.0
9.0
7.0
5.0
6.0
4.0
5.0
4.0
3.0
5.0
5.0
3.0
7.5
5.0
5.5
1.5
0.5
1.5
2.5
-2.0
-4.0
-2.0
-3.0
-2.5
-4.0
-13.0
10.0
26.0
11.0
9.7
13.0
20.0
15.0
10.5
11.1
17.5
3.3
6.8
18.0
25.0
12.0
8.2
9.0
20.0
6.0
7.8
6.0
30.0
4.0
6.5
5.0
24.0
5.0
7.2
4.0
16.0
10.0
7.6
1.0
15.0
7.0
7.2
2.0
8.0
9.0
9.9
10.0
5.0
11.0
3.5
6.0
7.0
8.0
11.0
13.0
10.0
10.0
9.0
3.0
-3.5
-3.9
-5.6
Source: MOSL, Company
Exhibit 19: Consumption demand had been impacted in 3QFY15
Company
Hindustan Unilever
Havells
V Guard
Management Comments
Volume growth for the industry was merely one percent and value growth five per cent. This is likely to be the last
quarter where volume growth will be tepid. The slowdown has bottomed out and from the next quarter or so, we
should start seeing volume pick up across segments.
Ground situation have not seen much change in 4QFY15 vs 3QFY15, and thus expect similar revenue growth rates in
4QFY15 as well.
Revenue growth of 12% this quarter has been subdued on the back of continued weakness in consumer sentiment
with footfalls not improving and construction demand yet to pick up. To conclude, the on ground scenario continues
to be soft with channel health still to improve.
Source: MOSL, Company
23 February 2015
8

| CAPITAL GOODS INSIGHTS
Government has also cut Planned Expenditure meaningfully, impacting the cash flow cycle for
contractors and equipment manufacturers
Exhibit 20: Government has cut Planned Expenditure to
achieve the deficit targets…
Budget estimates
4.9
4.6
5.2
4.1
Revised/Expected
4.9
4.2
4.5
3.7
Exhibit 21: …and the amount has been stagnant YoY, lowest
growth levels in several years
Plan Expenditure (YoY %)
22
23 25 23
19
16 18
6
19
11
7
0
19
17
2
4
FY12
FY13
FY14
FY15
Source: Government, MOSL
Source: Government, MOSL
Exhibit 22: 12mma Order awards at INR2.1t are up 29%
YoY…
TTM Orders (INR b)
% YoY
Exhibit 23: …, but on 3mma basis, Order awards decline
from peak levels in Sep-Nov 14
40
20
0
-20
-40
-60
-80
3mma Orders
% YoY
150
100
50
0
-50
-100
-150
Source: MOSL, Industry
Source: MOSL, Industry
Exhibit 24: Bearings / Abrasives companies have reported
some moderation in revenue growth (% YoY)
Bearings, % YoY
IIP 3mma, % YoY, RHS
Abrasives, % YoY
20%
10%
0%
-10%
Exhibit 25: Capacity utilization in the industry has declined
meaningfully
85
80
75
70
65
60
CU %
IIP Index
188
176
164
152
140
60.0%
40.0%
20.0%
0.0%
-20.0%
-40.0%
Source: MOSL, Company
Source: RBI
23 February 2015
9

| CAPITAL GOODS INSIGHTS
Exports hamstrung by weak global demand
Sharp decline in ‘oil’ prices has impacted global investment cycle
Since Sep 2014, growth rates in Indian Machinery goods exports have decelerated
meaningfully to just 2.6% (3mma, Dec 2014) vs 13.6% (12mma, Dec 2014). Export
performance has been hamstrung by a multitude of factors, including: i) weak
global demand conditions, ii) geopolitical tensions and iii) sharp currency volatility
in several markets. Sharp decline in crude prices by ~USD50/bbl has impacted
global trade by ~USD2t and led to a meaningful decline in aggregate global
investment demand. Overseas project awards, particularly in the Middle East, are
down 52% YoY at USD17.7b (3mma) and are near the lowest level of the range
since 2007. Revenues of global industrial players (eight companies accounting for
~7-8% of global capex) suggests that the sluggishness in both order intake and
revenues have continued for ~8 quarters now.
An important monitorable for Indian companies is the sharp depreciation of EUR,
and this has improved the competitiveness of European players in the traditional
markets of South East Asia and Africa. The real appreciation of INR may also have
had some effect on slowing exports.
#1
Indian Machinery exports growth moderated meaningfully in 3QFY15
Since Sep 2014, the Machinery and Engineering goods exports growth has
decelerated meaningfully to just 2.6% (3mma, Dec 2014) vs 13.6% (12mma, Dec
2014) and comes on the back of a very strong growth in the first 8 months of CY14.
Export performance has been hamstrung by a multitude of factors, including: i)
weak global demand conditions, ii) geopolitical tensions, iii) sharp currency volatility
in several markets and iv) decline in energy and commodity prices impacting global
investment cycle. The real appreciation of INR may also have had some effect, which
had supported exports during the early part of 2014.
Another important monitorable for Indian companies is the sharp depreciation of
EUR which has improved the competitiveness of European players. The traditional
markets for Indian engineering exports have been South East Asia and Africa.
Increased competitiveness of European players in these markets will be keenly
watched.
Exhibit 26: Indian Engineering Exports – Increased caution
Company
Cummins India
Management Comments
When you look at our high-horsepower engine exports, when I look at the market picture, it's not very exciting. These
engines are going into power generation and mining markets primarily, and both are very depressed markets right
now all over the world. So, I'm not very optimistic of growth in that area. So unless there's a pickup in the global
economy beyond North America, I would say probably low-teens is what I would guide.
China, which is a source of huge concern, continues to be a problem for us. We are struggling to move our sales up.
We are now re-grouping the entire strategy of the company as far as China is concerned.
Europe remains weak and is in danger of continued recession. Meanwhile, with the steep correction of international
crude oil prices, the Middle East geographies (more relevant to our operations), are expected to tone down their
spending over a period of time. However, the respective countries have for now, maintained their budgets and
growth targets, perhaps awaiting the outcome of the next OPEC meeting scheduled in June 2015.
Source: MOSL, Company
Elgi Equipments
Voltas
23 February 2015
10

| CAPITAL GOODS INSIGHTS
Exhibit 27: Machinery export growth has decelerated
sharply to just 2.6% in Dec 2014 (3mma, % YoY)…
70%
50%
30%
10%
-10%
-30%
Exports
Imports
Exhibit 28: …On a 12mma basis, Machinery exports growth
stood at 13.6% in Dec 2014 (12mma,% YoY)
50%
30%
10%
-10%
-30%
Exports
Imports
Source: CMIE
Source: CMIE
Exhibit 29: The Real appreciation of INR may also have had some effect, which also
supported exports during the early part of 2014 (USD B, ttm)
65
63
61
59
57
55
53
INR/USD (LHS)
REER (RHS)
110
105
100
95
90
85
Source: MOSL, Company, Company
Exhibit 30: Indian Capital Goods Players - FOB Exports (INR B)
FY09
SIEM
ABB
KKC
TMX
CRG
LT
BHEL
BEL
VOLT
KECI
VATW
Total
% of Rev
2.6
4.8
13.1
6.4
10.3
16.5
15.7
0.8
0.3
7.2
0.0
69.4
8.0
FY10
2.0
4.6
4.9
7.1
10.0
5.1
12.3
1.1
0.3
4.7
0.0
46.0
4.7
FY11
3.7
4.6
10.6
6.2
8.6
5.6
7.7
1.6
0.5
4.4
0.6
47.0
4.0
FY12
3.3
8.2
11.9
7.3
7.7
8.4
10.1
1.9
0.3
7.6
2.2
56.9
4.1
FY13
5.1
8.7
12.7
6.7
7.5
10.2
4.4
1.8
0.3
7.6
1.9
55.3
4.0
FY14
4.1
9.4
12.0
10.4
8.9
10.1
13.6
2.5
0.3
8.8
3.2
68.5
5.1
% of
Sales
3.9
12.3
30.8
19.8
11.9
1.6
3.5
4.1
0.5
13.4
15.3
CAGR
(FY09-14)
10
14
-2
10
-3
-9
-3
25
1
4
Source: MOSL, Company
23 February 2015
11

| CAPITAL GOODS INSIGHTS
#2
Global industrial companies suggests several uncertainties surrounding
growth; Revenues / orders remain sluggish for 8 quarters now
Revenues of the global industrial players (eight companies accounting for ~7-8% of
global capex) suggests that the sluggishness in both order intake and revenues have
continued for ~8 quarters now. There was a sense of cautious optimism during early
2014, and given the various uncertainties, the expected improvement during this
period has remained elusive. Also, the outlook as stated by various companies
suggests several uncertainties for CY15.
Exhibit 31: Global industrial companies report sluggish
revenues for 4 quarters (down 1% in 4QCY14, ttm, % QoQ)
7.0%
Revenues ttm % QoQ
Exhibit 32: Revenues on a YoY basis also continue to remain
sluggish, down 1.1% in 4QCY14 (ttm, % YoY)
20.0%
10.0%
0.0%
Revenues ttm % YoY
2.0%
-3.0%
-10.0%
-8.0%
-20.0%
Source: Company ; Aggregate revenues of eight global companies
contributing ~7-8% of the global capex
Source: Company; Aggregate revenues of eight global companies
contributing ~7-8% of the global capex
Exhibit 33: Global industrial companies - Increased uncertainty for 2015 led by volatile currencies, decline in raw material
costs and geopolitical tensions
Company
Caterpillar
Management comments
We expect world economic growth to only improve modestly in 2015. The relatively slow growth in the world
economy and continued weakness in commodity prices - particularly oil, copper, coal and iron ore - are expected to
be negative for our sales. Back in October 2014, we expected sales and revenues would be flat to slightly up. Our
current view is that sales and revenues will be about USD50b and that's down over 9% from 2014.
There are continued risks from geopolitical tensions, volatile currencies, and the raw material prices. In the short
term, we expect a significant CapEx decline and some project delays associated with the oil price development. These
developments are already visible in the tendering activity of our oil-and-gas-related businesses, such as Power and
Gas and Process Industries and Drives.
Our upstream backlog has held firm. We are beginning to see some delays further downstream in countries that are
net oil producers, such as Russia and the Middle East, as refining and petrochemical product decisions are deferred.
How the current market uncertainties will impact customers' investment decisions is not yet clear, and therefore our
market outlook remains cautious.
We are currently forecasting total company revenues to grow between 2% and 4% in 2015, with growth in North
America, new products, and distributor acquisitions offsetting continued weak international markets and the negative
impact of a stronger U.S. dollar.
In the short term, macroeconomic and geopolitical developments are signaling a mixed picture with increased
uncertainty. Some macroeconomic signs in the US remain positive and growth in China is expected to continue. At the
same time, the market remains impacted by slow growth in Europe and geopolitical tensions in various parts of the
world.
Source: MOSL, Company
Siemens AG
Honeywell
Wartsila
Cummins Inc
ABB
23 February 2015
12

| CAPITAL GOODS INSIGHTS
INTERESTING COMMENTS: M S Unnikrishnan, Managing Director and CEO, Thermax
“Oil price decline impacting Global Investment cycle:
First and foremost is when the oil prices
crashed from maybe USD110 in an average for the previous year to may be less than USD50, the
world is going to be missing approximately USD50 per barrel at 93m barrels per day. Very simple
Arithmetic will turn it to little more than USD2t that is going to be missing in trade from the world.
That money normally will also get into reinvestment in various other sectors. So suddenly there will
be a dip in the investment cycle for the entire globe”.
“Increased competitive intensity in overseas markets:
An important factor, which we need to be taking in the
consideration is EUR becoming weaker, and the expectation of the market is that it may even touch almost at parity
level with USD, making European companies very competitive in the limited market of South East Asia and Africa
where we are currently able to compete against Japanese, American and Korean companies to pick orders. But if
European companies were to look at this as an opening available for them based on the currency depreciation, the
competition then becomes tough. Please remember against a Chinese when we compete, we get a price premium;
against European we have to give a price discount to get an order. So that is why I mentioned about this
specifically”.
#3
The Middle East project awards have declined; margins bottoming out
(after being impacted by project specific losses)
Overseas project awards, particularly in the Middle East, in 3QFY15 have been
muted, impacted by the sharp decline in crude oil prices. Aggregate project awards
in the Middle East are down 52% YoY at USD17.7b (3mma) and are near the lowest
level of the range since 2007.
L&T has also witnessed a meaningful decline in overseas project awards at just
INR45b (v/s average award of INR115b in 4 quarters till June 2014). Also, the EBIDTA
margins in hydrocarbons were again negative at 4.8% v/s breakeven in 2QFY15 and
project specific losses of INR8.9b in 1QFY15. Our analysis of the key Korean
contracting companies (including Samsung, Daelim and Hyundai) indicates that the
gross margins at just 3.1% (12mma) continue to remain sluggish.
Several global contractors have stated that there exists enough liquidity in the
system for the ongoing capex to continue in the interim period, we would still be
watchful of the trends.
23 February 2015
13

| CAPITAL GOODS INSIGHTS
Exhibit 34: The Middle East project awards (3mma) have
declined to near low levels since 2007
80.0
60.0
40.0
20.0
0.0
USD B
% YoY
300%
250%
200%
150%
100%
50%
0%
-50%
-100%
Exhibit 35: The Middle East Project awards (12mma) had
peaked in mid 2014; down 30% from those levels
180
160
140
120
100
80
60
USD B
% YoY
100%
80%
60%
40%
20%
0%
-20%
-40%
-60%
Source: CMIE
Source: CMIE
Exhibit 36: Korean contractors have witnessed stable order
awards (KRW B)
20,000
15,000
10,000
5,000
-
Order Intake
Exhibit 37: Gross margins of the Korean contractors have
remained sluggish (12mma, %)
Source: MOSL; Korean players quarterly results
Source: MOSL; Korean players quarterly results
23 February 2015
14

| CAPITAL GOODS INSIGHTS
Ray of Hope: Initial signs of activity picking-up
Emerging areas: Defense, Renewables, Railways
I
Capex by Foreign players
While the step-jump in investment cycle during the earlier decade (2002-2012)
was led by sectors like Telecom, Power, Roads; we believe that the step-jump in
the coming decade would be primarily driven by the emerging sectors of Defense,
Railways, Renewables and Water. Several announcements by the government and
policy initiatives over the last six months now provide a Ray of Hope. Another
important trend is the surge in projects added by the Foreign companies (with
share increasing to 27% in Jul 2014 – Jan 2015 v/s just 8% in the preceding seven
months) and the trends have been in-line with history. CEOs of global industrial
companies have also echoed positive sentiments on increasing investments in
India.
#1
Please refer our detailed
sector report on “India’s
Capex J-Curve” in April 2013
Emerging areas of Defense, Railways, Renewables and Water to drive
accelerated pace in investment cycle
Both Indian Defense and Railways present interesting opportunities for the
contracting companies and capital goods equipment suppliers, given that ~INR2.4t
of defense / INR300b of DFCC contracts are to be awarded over the next 1.5-2 years.
In addition, several large projects in Railways (like High Speed Rail Corridors and
Metro rails), Renewables (Solar, Wind with target to set up 160GW capacity,
investments of USD250b) and Water (River Interlinking, River cleaning, Irrigation)
also present sizeable investment possibilities over the medium term.
Exhibit 38: Indian Defense – ‘Make in India’ is a strong resolve; several steps in offing with
key government decisions
Please refer our detailed
report “India Defence”
in January 2015
Source: MOSL, Company, Company
23 February 2015
15

| CAPITAL GOODS INSIGHTS
Illustration: NTPC’s plan in Solar
“NTPC is developing the world’s largest solar power project of 1GW at Anantpur in AP in a phased manner. In the
first phase, NIT has been issued for 250MW for five blocks of 50MW each. Also, to kickstart domestic manufacturing
cycle, NIT for additional 750MW solar has been issued. Out of this, projects of 250MW each will be set up in MP,
Telangana and Rajasthan”.
#2
Foreign companies looking to increase investments in India
Of the cumulative fresh projects added (conceptualized) by the private sector during
Jul 2014 – Jan 2015, share of the Foreign companies stands at 27% (v/s just 8% in
the preceding seven months), which has been a key surprise. Thus, while net
projects added by the private (Indian) sector is up 2.4x in this period, net projects
added by Private (Foreign) is up 9.6x. Several of these projects are largely in
segments like Food Processing, Chemicals, Pharma and Automobile.
Exhibit 39: Projects add by the Foreign players have witnessed a strong surge (INR B,
3mma)
2,000
1,500
1,000
500
0
Private (Indian)
Private (Foreign)
Source: Projects Today
We believe that sudden surge by the foreign players is possibly also explained by
trends in history:
n
Foreign players typically follow a more disciplined approach towards creating
capacity, and the decisions are based by taking a more long-term view on
anticipation of a possible demand surge. Recently also, Global CEOs of several
MNCs have acknowledged the possible surge in Indian demand environment
and need to augment capacities to prepare better.
n
Indian players, on the contrary, will typically wait for improved clarity on the
macro environment, in an attempt to match capacity with demand. As demand
starts improving, several players start pressing the panic button to create
capacity and push equipment manufacturers for accelerated deliveries. Similar
trend was also witnessed during the past cycle, when Indian players in segments
like power generation and cement threatened capital equipment manufacturers
with Chinese competition, to reduce the project delivery time periods by ~30-
35%.
23 February 2015
16

| CAPITAL GOODS INSIGHTS
Exhibit 40: CEOs of
global
industrial companies have echoed positive sentiments on increasing investments in India
Company
Siemens AG
Management comments
On the positive side, we expect to benefit from higher investment in infrastructure due to lower energy bills, in
particular emerging economies such as India and increased demand from automotive and downstream customers.
India, there could be an awakening in India, and I've never seen such excitement in the business community in the 20-
plus years that I've been going there. So I'm actually pretty encouraged about what they could be doing. And I really
think there could be a takeoff there that we've all really been waiting for, for at least 10 or 12 years now. And that
one could turn out to be quite a good positive.
In India, we expect total revenues, including joint ventures, to increase 5%. The new government has made
infrastructure investment a big priority, and we're cautiously optimistic that demand will improve in the second half
2015.
The Make in India policy, it is really a strong requirement to set up industrial value chains, even stronger than the
country has done so far will accelerate growth and create jobs and create prosperity, so that is a good one. The easing
off of export policy and making it possible to export easier from India is another element. The changes that we see
and the legislation that is being put in place on the renewable energy side is another piece. So all together they are
some really good pieces of the future jigsaw puzzle of the prospering India that will help to get this country to the
next level of better quality growth.
Source: MOSL, Company
Honeywell
Cummins Inc
ABB Inc
23 February 2015
17

| CAPITAL GOODS INSIGHTS
Sector strategy: BHEL, VOLT, CRG are top picks
Key trends to focus: Mid-value products; accelerated execution in ‘stuck
projects’
In our opinion, India's capex J-Curve would be kick-started by (1) reorientation of
fiscal expenditure which could accelerate spending on government flagship projects,
and (2) government's attempt to address the contentious issues in several sectors,
leading to increased capex by CPSUs. This phase would be followed with revival in
industrial cycle culminating with traction in greenfield projects.
Another important agenda will be to reap the benefits in terms of increased
efficiency of the existing infrastructure assets that have been created and are largely
stranded. For instance: Increased mining efforts and lowering AT&C losses would
meaningfully lower electricity costs and improve viability in several sectors of the
economy. During Tenth / Eleventh Five Year plans (from FY03-12), ~48% of the infra
investments were towards power and roads, and given the stuck projects in these
segments, the efficiency gains have not yet fully percolated in the system.
Sector View: Earnings prone to downgrades; Valuations demanding
While a sharp recovery in investment climate in the medium term is definitely
possible, we believe that earnings growth in FY16/FY17 are prone to downgrades.
Slowdown in consumption growth is a worrying signal and improvement in business
sentiments are yet to reflect in on-ground actions. Thus, revenue growth may
remain weak for few more quarters. Valuations for most companies are demanding,
and factor in a sharp rebound in investment climate.
We believe that the initial round of project awards may well be a winner's curse.
This is because PSU capex is characterized by tender based bidding, elongated
working capital cycles and continued execution delays.
We identify three trends to focus based on structural drivers:
n
Mid-value products business are typically early to mid cycle plays and have
meaningful operating leverage
(TMX, KKC, CRG, ABB are key beneficiaries).
In
this environment, we believe mid-value product companies are better
positioned than project companies: (1) minimum threshold demand exists
because of exposure to base industries and also large replacement demand, and
(2) they enjoy a dominant position, and thus better control on margins.
n
Projects business should witness improvements in free cash flow generation led
by normalization of cyclical factors
(L&T, BHEL key beneficiaries)
and
n
Increased contribution of overseas business
(L&T, TMX, KKC, VATW)
Top Picks:
BHEL, CRG & VOLT are Top Picks to play the possibility of an uptick in the
investment climate. Despite near term headwinds, we remain positive on L&T, from
a long-term perspective.
23 February 2015
18

| CAPITAL GOODS INSIGHTS
Exhibit 41: Comparative and valuation
Company
ABB#
BHEL
Crompton
Cummins
L&T
Siemens##
Thermax
Havells
Voltas
BEL
VATW
Rating
Neutral
Buy
Buy
Buy
Buy
Sell
Buy
Neutral
Buy
Buy
Buy
M-Cap
USD
4.8
10.8
1.8
4.0
25.2
7.3
2.3
2.7
1.4
4.8
0.4
0.8
CMP
INR
1,414
273
177
897
1,686
1,279
1,212
268
253
3,727
86
1,713
EPS (INR)
P/E (x)
FY15E FY16E FY17E FY15E FY16E FY17E
10.8
7.3
3.7
24.1
41.4
8.7
25.0
8.0
10.4
2.4
43.4
17.2
12.2
8.7
26.8
53.9
14.2
33.0
9.8
12.8
5.0
61.7
27.1
17.7
13.8
32.2
72.2
18.7
46.1
12.2
15.8
7.8
81.8
131.1
37.2
48.3
37.2
40.7
146.9
48.5
33.6
24.3
24.5
35.1
39.5
82.3
22.4
20.3
33.5
31.3
90.2
36.8
27.2
19.7
20.7
17.1
27.8
52.2
15.5
12.8
27.9
23.4
68.4
26.3
22.0
16.1
18.9
11.0
20.9
EV/EBITDA
RoE (%)
FY15E FY16E FY17E FY15E FY16E FY17E
54.8
21.2
17.6
32.0
24.4
74.7
30.0
19.4
19.5
19.9
8.4
19.2
41.0
12.4
11.5
29.0
21.0
48.0
22.0
16.3
15.8
16.1
6.2
13.8
29.1
8.5
8.1
24.2
17.0
38.6
16.3
13.5
12.2
14.1
4.9
10.6
8.3
5.3
12.9
24.3
12.6
7.4
14.1
27.9
16.5
15.3
4.8
12.4
12.5
8.4
12.8
24.6
13.7
10.6
17.0
27.3
17.8
15.9
9.1
15.5
17.9
11.3
18.0
27.4
14.9
12.6
21.0
28.8
18.9
15.4
12.8
17.7
151.8 179.7 197.6
KEC Internl. Not Rated
# Dec Year end, ## Sept Year end
Source: Company, MOSL
23 February 2015
19

| CAPITAL GOODS INSIGHTS
23 February 2015
20

| CAPITAL GOODS INSIGHTS
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23 February 2015
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