EPC companies drive the profit beat

Most companies reported in-line/beat in sales: Net sales for 19 of 21 companies were in line with or beat estimates, after almost 10 quarters. EPC (Engineering, Procurement and Construction) companies, particularly in the power sector reported a sales growth beat as their healthy order books led to improved execution, whereas most product companies reported in-line results as sales were deferred to Q3. Despite in-line/beat on revenue forecasts, only 9 of 21 companies reported a beat in net profit estimates. Again, EPC companies (power largely) drove the profit beat; some product companies with a favourable sales mix and operating leverage benefits aided the profit beat.

Observation duringthe quarter

Engineering exports see healthy growth: Engineering exports saw a sharp increase of 26 per cent YoY in CY17, thus narrowing the gap between engineering and exports and imports. The latter grew by only 4 per cent  over the same period.

Capital goods index growth accelerated: The capital goods index grew 11 per cent YoY in Q3FY18 and 3.8 per cent in 9MFY18. The growth was primarily led by sales of welding machinery, commercial vehicles, air filters, hydraulics, furnaces, sugar machinery, paper machinery and ship building parts.

 

What we prefer

Bharat Electronics: We believe BHE is the only sizeable play in India’s defence sector that is likely to see a surge in investments due to the government’s increased focus and policy initiatives, as it derives more than 85 per cent of its revenue from the defence segment. BHE displays traits of consistent growth and resilient performance due to its robust order book position (4.0x TTM sales), secular growth over the past 15 years with no cyclicality (11 per cent /15 per cent CAGR in sales/net profit over FY02-17), strong R&D franchise as it incurs 9 per cent of sales as R&D (87 per cent of products developed in-house/along with DRDO) and strong moat due to its deep-rooted presence in large-value defence contracts. We forecast 17 per cent /12 per cent CAGR in revenue/profit over FY17-20 and expect strong free cash flows despite large capex planned over the next three years.

Voltas: Voltas is favourably placed to grow sturdily given its leadership position in the low-penetrated room AC market (24 per cent share) and its transition into a full-fledged consumer durables players with the scheduled launch of refrigerators, washing machines and microwave ovens in FY19. The project segment (44 per cent of net sales; 22 per cent of EBIT) has a healthy order book of INR 49bn (1.7x TTM sales) and margins have also recovered from lows of 1-2 per cent  to 5-7 per cent in FY18. Its balance sheet remains strong with net cash of more than Rs 2,500 crore and we expect 13 per cent/15 per cent CAGR in revenue/profit over FY17-20.

Cochin Shipyard: Cochin Shipyard (CSL) is the largest shipyard in India in terms of dock capacity and a market leader in ship repair (39 per cent share). CSL is building India’s first aircraft carrier (IAC-1) and is also a top contender to build the second indigenous aircraft carrier (IAC-2). In our view, CSL is likely to see sustained double-digit growth based on its robust order book position (12x TTM shipbuilding sales including L1 orders), favourable industry positioning, low-cost structure, conducive government policies, new business partnerships (JVs with Hooghly and Mumbai Port), strong financials (debt free despite high capex) and experienced management (top management’s experience is >25 years). We forecast 29 per cent/16 per cent revenue/profit growth over FY17-20.

Source: JM Financial Institutional Securities