Indian cap goods: Rising relevance of globalization
Expectations of quick revival in
investment cycle are pivoted upon expeditious project clearances and
execution under the new government. However, the fact that clearances of
152 projects worth Rs 5.3tn (5% of GDP) by the previous government failed
to reinvigorate private investment suggest factors outside of the ambit of
clearances may be more relevant.
The fundamental hindrances are slow to thaw: Agnostic
to governments, private investments are a function of sales growth, return
on capital, cost of doing business, balance sheet strength and operating
leverage on the one hand and the Saving-Investment mismatch on the other.
These variables have still not moved much over the past three months; the
land acquisition bill still stands intact and reforms in labor law looks
distant.
See no immediate revival in investment cycle: After
analysing the structural and cyclical indicators and based on empirical
evidence*, we feel that expectations of a turnaround in the domestic
investment cycle are premature. The following are a few relevant
observations-
n New
investment projects started have halved from Rs 1.8 tn a year ago to Rs 900
bn in Q1FY15 with a steep increase in investment projects dropped.
n Slowdown
in non-food credit growth to sub 10% and decline in sales growth for
non-finance companies to 4.7% in FY14 from 9.1% in FY13 are fairly strong
evidence to portend weak private sector investment in FY15.
n Decline
in non-food credit growth possibly reflects tightening credit conditions
(regulatory or initiated by banks) and can sustain asset quality concerns.
Till the fundamentals
adjust adequately, we believe that domestic investment cycle will meander
around low growth trajectory, if not weaken further. As of now nothing has
changed on the ground. Most companies we met believe that it will be around
18 months before investment cycles start turning around.
Increasing significance of global business for domestic
Cap goods: We have observed that domestic
capital goods companies across market caps and regions are aggressively
looking to diversify into global tenders and businesses, rather than
continuing to concentrate on domestic industry; a trend we believe could be
structural in nature. In developed markets, companies are engaging in
arrangements to neutralize the lack of acceptance of made in India
brand. In general, sales breakup of capital goods companies suggest an
increasing proportion of global businesses. Strikingly, capital goods
export/imports has risen to 70% in FY14 from 33% in FY08.
Investment theme: Prefer global businesses with high
product plays
We
believe that the general market enthusiasm regarding in capital goods
companies may be a bit exaggerated. Exports of capital goods/capital goods
imports has risen from a low of 33% in FY08 to 70% in FY14, thereby
extending the structural reliance on global market since FY96 when the
ratio was at a low of 20%. We believe
businesses having significant share of global revenues with product plays
deserve higher valuations. Our stock picks are driven by a)
Business model –bias in favour of product companies with increasing
share of export revenues, b) business visibility, c) balance sheet
strength, d) cash flows, and e) RoCE. Our
conviction buys are Symphony, TD Power Systems, LMW and Cummins.
But based on our export-product-EPC matrix we also like companies such as ABB India, Alstom T&D, Siemens,
KEC International and Kalpataru Power. In the large caps we maintain our
preference for L&T and avoid view on BHEL.
