Capital goods firms at pre-Modi days

Wed, 15 Jul Pre-Open

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There has been seen slower government spending for industrial production data for the month of May 2015. This due to the muted growth witnessed in capital goods output. The NDA government has been in power for a year now but has failed to boost the pace of delivering orders in the past few quarters to capital goods firms.

An article in Livemint reports that growth in capital goods sector was 1.8% YoY in May after rising by 6.8% in April. This is seen as an indication that revival in capital investments has been inconsistent. Apart from private sector orders, even government orders have languished except in select sectors such as defence and National Highways Authority of India (NHAI). A sharp decline for orders is seen in water, irrigation and state roads. Large orders are getting finalized periodically while the finalization of smaller orders is delayed. Further, capital goods companies are being cautious in taking any new orders. This is due to the execution delays faced by them in their existing order book. This lag is affecting their cash flow patterns too. The industrial outlook on the back of these concerns is also viewed as uncertain.

With these concerns, hopes are set on the budget outlook which has allocated a 30% increase on capital spending. Questions are raised on the budget for translating this increase into investment-led recovery. With this increase it is estimated that orders in the railway and highway sectors will surge, provided NHAI and Indian Railways manage to secure long term funding. Also, the momentum of public sector projects in the power transmission and distribution and metro-rails is expected to continue.

In line with the data, valuations of capital goods companies are around 2007-08 levels. Finally, Investors are trimming their positions to some of the stocks which have sizzled in the past one month on hopes of continuing revival in the concerned segment. As a conclusion, order inflows needs to pick up substantially to justify the high valuations.

On investing side, investors should be attentive to these undergoing economical changes in any particular sector. They should compare the YoY (year-on-year) increase in performance standards across various parameters when analyzing those sectors. The company which is covered in that sector gets influenced by the sectoral changes. Therefore investment decisions should be made accordingly. However, the main criteria for your investments should be looking into the underlying business of a company and not solely the performance of the sector. Sectors are influenced by these economical changes but the main performance drivers are the internal factors of a company. These are the management ethics, financial ratios, cost of capital, return on capital and retained earnings.

We would recommend you to be aware on both the sides. The macro as well as the micro side has to be kept in mind while altering your portfolio. If a sector is underperforming for a prolonged period of time, the company which you are concerned has also to be vouched thoroughly before coming to any conclusion. On the other hand if a company is underperforming while there seems to be sectoral prospects that can benefit the company, it is a clear red flag.