23 February 2015 | Vol – 3 / 2015
CAPITAL GOODS INSIGHTS
The Butterfly Effect
Investment cycle gradually gaining momentum; Exports hamstrung by weak global demand
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
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
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, ii) increased FDI
limits, iii) expediting approvals and iv) supportive
monetary conditions should create a conducive
setting for industrial revival in the medium term.
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
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
We believe that the initial round of project awards
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
East are near the lowest level of the range since
(AgarwalS@MotilalOswal.com); +91 22 3982 5410
(Amit.Shah@MotilalOswal.com) ; +91 22 3029 5126
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