Capital woes

For the capital goods industry, working capital pressure is likely to persist for sometime as clients’ liquidity remains under pressure and vendors are demanding shorter payment cycles

Capital woes
The sedated environment, working capital pressures and liquidity concerns have forced the capital goods companies into a situation where L&T, Bharat Heavy Electricals, ABB, PowerGrid, Siemens and Crompton Greaves have found themselves sailing in the same boat with severe margin pressures and equally strong competition among themselves to secure any significant order worth its salt to sustain themselves.

The working capital pressures are most likely to persist at least in the near term, as client liquidity remains under pressure and vendors are demanding shorter payment cycles for companies involved in engineering, procurement and construction jobs, say experts.

Prakash Gaurav Goel, a senior analyst with ICICI Securities, says the management outlook of L&T is positive in certain pockets such as urban infrastructure, transport, water, hydrocarbons and transmission and distribution segments. “However, power generation, domestic hydrocarbons, refining and petrochemicals and process metals present a weak outlook, given the relatively low prospects for incremental capacity addition in the near future,” said Goel.

Analysts believe although L&T does not intend to follow the herd mentality to gain orders in low or no-margin opportunities, the company will not be immune to pricing pressures and its margins will remain under pressure despite selective order bookings.

There has been strong competition from domestic as well as foreign players in the boilers, turbines and generators (BTG) space, since the market in Europe and the US has reached a plateau. Also, the Indian government has imposed a 21 per cent import duty on power instruments, which would lead to foreign companies setting up manufacturing plants in India.

Analysts believe this would increase competition in the domestic market and that may force Indian companies to go for expansions as well.

Demand for BTG has dropped since overall execution of power projects has come down over the past five years due to overall weakness in the economy. Against a huge pipeline of around 46,000 MW of cumulative thermal power capacity planned by key states, such as Maharashtra, Rajasthan, Andhra Pradesh and Tamil Nadu, the demand from states has been only 10 GW in the past three-and-a-half years, while the year 2009 alone saw 10 GW orders.

Kotak Securities said in a report that its understanding and industry feedback suggest that independent power producers (IPPs) may be out of the market for a long time, maybe more than two years, as project executions are not happening as expected. IPPs accounted for most of the ordering for Bhel in 2010-11

Besides, many bulk tender projects face the risk of non-compliance from bidders that do not have manufacturing capacities, as well as execution risk in case of land acquisition or clearance issues. In total, about 11 GW of bulk tenders out of 14 GW tendered suffer from either of these risks. “The joint ventures of BGR Energy and Bharat Forge are responsible for supplying equipment for about 9 GW of projects out of the 14 GW of bulk tender awards. In case they are not able to meet the target, there may be penalties as high as the cost of project,” said the report.

Also in the transmission segment, PowerGrid’s ordering is likely to plateau, as most of the 12th plan projects have already been tendered out. However, analysts believe upside possibilities exist from green energy corridors with investment plan of Rs 40,000 crore as well as from intra-state sub transmission strengthening projects.

“We expect project awards to accelerate in 2014 and 2015. Several of these projects will necessitate technology upgrade by Indian companies,” said a report by Motilal Oswal Securities.

Analysts also believe that the profitability in power products has eroded over the past four years, with pre-tax margins declining to 7-8 per cent from the peak of 15-19 per cent in 2009. This is a function of increased competitive intensity, resulting in 25-30 per cent decline in transformer prices. However as product prices have bottomed out and raw material prices have eased, margins are showing signs of stabilisation.

On the back of PowerGrid orders, the demand for power transformers has risen around two times from 2008 levels, while the demand for distribution transformers continues to be at 2008 levels.

“We believe power products should see improved demand environment, given that several SEBs have raised tariffs over the past 18 months. The financial restructuring proposals of SEBs will also lead to improved liquidity. Their debt restructuring proposals will also lead to improved liquidity. Successive grid failures in the north and northeast in July 2012 could also lead to some sense of urgency in terms of correcting the cumulative under-investment in the sector,” Motilal Oswal said in its report.

Stock performance

Capital goods stocks have underperformed Sensex this calendar. The BSE capital goods index has dropped 6.44 per cent year-to-date, compared with a 0.30 per cent rise in Sensex.

Punj Lloyd, Fag Bearings, Alstom India and Crompton Greaves have tanked 17.39 per cent, 15.50, 13.31 per cent and 10.66 per cent, respectively. BHEL declined 8.71 per cent.

“BHEL’s Q3 results disappointed us on all fronts, with revenues declining for the first time in a decade and Ebitda margin compression significantly higher than our estimate. Poor order inflow and lower execution have resulted in margin compression and deterioration in working capital. We expect further margin compression in FY14E,” said Krishnakant Thakur of Espirito Santo Securities in a note.

L&T too declined 6.01 per cent on weak operating performance.

“In our view, underlying trends for revenue growth and margin are clearlyweak though strong order inflow is a continued indication of the company focusing on actively exploring new geographies and segments to gain market share. We have been concerned about the company winning orders at the cost of weakening margins and, to an extent, this seems to be playing out, though quarterly trends are not fully reflective of full year numbers for L&T,” said Amar Kedia of Nomura India in a result note.

Suzlon Energy (34.23 per cent) and Havells India (4.82 per cent) were the only two scrips that bucked the weak trend. zz

(With inputs from Amit Mudgill)


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